Fundamental analysis

How Often Should We Rebalance Equity Factor Portfolios?

10.May 2022

Quantpedia has already covered a countless number of factor investing strategies and articles, from strategies in our Screener to multiple blog posts. Therefore, we can confidently say that we do like factor investing. However, there is always new research with a unique point of view. For example, we recently found a paper focused on the decay of the factor exposures of equity factor strategies. The study examines five factors: Value, Momentum, Quality, Investment, and Low Volatility, across 12 developed and emerging markets over a 20-year period. This research aims to find out how long it takes for a factor to decay after the portfolio is assembled. In other words, how often should the portfolio be rebalanced? 

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VIX-Yield Curve Cycles May Predict Recessions

21.January 2022

Since recessions and bear markets come hand in hand for several asset classes, recession predictions have always been the foremost concern. The yield curve slope, defined as the difference between long and short-term rates, is the leading indicator backed by numerous research papers. Hansen (2021) builds on this theorem, but the author improves the recession prediction by his empirical observation that the VIX index (index of implied equity volatility or fear index) and the slope co-move in counterclockwise cycles, which align with business cycles.

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How News Move Markets?

12.November 2021

Nobody would argue that nowadays, we live in an information-rich society – the amount of available information (data) is constantly rising, and news is becoming more accessible and frequent. It is indisputable that this evolvement has also affected financial markets. Machine learning algorithms can chew up big chunks of data. We can analyze the sentiment (which is frequently related to the news). Big data does not seem to be a problem anymore, and high-frequent trading algorithms can react almost instantly. But how important is the news? Kerssenfischer and Schmeling (2021) provide several answers by studying the impact of scheduled and unscheduled news (frequently omitted in other news-related studies) in connection with high-frequency changes in bond yields and stock prices in the EU and US as well. The research points out that the effect is tremendous and significant.

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An Investigation of R&D Risk Premium Strategies

19.March 2021

The R&D investments represent a company’s unique expenditure, which is responsible for creating an information asymmetry about the firm’s growth potential and future prospects. In a case when market value reflects only the firm’s financial statements without taking the long-term benefits of R&D investments into consideration, the company’s stocks may be underpriced. On the other hand, the firm’s stock prices may also face overpricing. This might happen in a case when the investors judge the possible future outcomes of current R&D investment based on the past firm’s R&D success, which is not a guarantee by any means.

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Macro Factor Risk Parity

29.January 2021

Risk and diversification are critical interests of every investor, especially when things go south since the correlations across assets tend to rise during stressful times. Therefore, in the asset allocation, the risk parity allocation is one of the key topics. Factors are commonly known as underlying sources of both risk and returns, and it is assumed that they can be utilized to achieve superior risk-adjusted returns and diversification. However, there seems to be a lack of research that would be related to the macro factors. This gap is quite striking since there is a general consent that macro factors (for example, inflation) largely influence the broad set of assets. Amato and Lohre (2020) research paper fills the gap and studies the usage of macro factors as diversifiers in asset allocation.

The authors divide the macro factors to two groups, where the first consists of TERM, MARKET, USD, OIL and DEF (default risk), and the second group consists of CLI (a measure of output by OECD), G7.INFLATION, G7.Short.Rate and VIX. The research shows, that when the diversification matters the most, only the second group improves both the risk and returns, acting as a successful diversification during various economic regimes and particularly, during high economic uncertainty. Overall, the paper offers exciting insights into diversification and macro factors, accompanied by more complex mathematical models definitely worth looking into.

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Crypto Covered Interest Parity Deviations

15.January 2021

Bitcoin and other currencies are frequently discussed nowadays. The debate has emerged mainly because of the strong uptrend in the Bitcoin price. In this blog post, we will leave the price patters to others. We will instead present interesting novel research connected to the well known theoretical model in the fiat currencies – the Covered Interest Rate Parity (CIP). If the CIP holds, interest rates and both the spot and forward rates of two countries should be in equilibrium. Novel research of Franz and Valentin (2020) examines the CIP in BTC/USD pair. The CIP theory states that there should be no arbitrage opportunities, but how the CIP holds in such a volatile market, where individual investors/traders seem to dominate? According to research, there were significant CIP deviations in the past, but it changed with the launch of BTC/USD futures in CME and high-frequency traders’ market entry. Moreover, the second event was much more successful in the reduction of deviations.

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