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…A Quantitative Approach

…A Quantitative Approach. Global Asset Allocation Term 3, 2005 Matthew Morse Jason Teeters J.J. Haines. Overview. Hypothesis: Develop a market-neutral long/short strategy Motivated by a “pairs trading” strategy which is designed to hedge industry specific risk

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…A Quantitative Approach

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  1. …A Quantitative Approach Global Asset Allocation Term 3, 2005 Matthew Morse Jason Teeters J.J. Haines

  2. Overview • Hypothesis: • Develop a market-neutral long/short strategy • Motivated by a “pairs trading” strategy which is designed to hedge industry specific risk • Identify a dynamic portfolio strategy which outperforms a general pairs trading strategy through the creation of a “basket” of securities • Industry-specific long and short “baskets” are identified on a monthly basis through a screen of targeted fundamental factors • Identify industry sectors which consistently produce excess returns

  3. Overview • Methodology: • Identify industries and potential fundamental factors • Screen and alpha test individual factors across industry sectors • Score and combine individual factors • Alpha test combined industry long/short “baskets” • Evaluate which industries produce consistent excess returns • Evaluate trading strategies

  4. Industries • Communications • Manufacturing • Transportation • Consumer • Healthcare

  5. Screens • Factors: Short Interest - total short positions currently open for a given equity as a percentage of total shares Fundamental Debt Factor - incorporates information about cost of debt and leverage ratio Change in Consensus – Percent change in EPS estimate (IBES)

  6. In Sample

  7. Healthcare Communication Consumer Products

  8. Manufacturing Transportation

  9. Healthcare – In Sample

  10. Communications – In Sample

  11. Consumer – In Sample

  12. Manufacturing – In Sample

  13. Transportation – In Sample

  14. Out of Sample

  15. Healthcare Communication Consumer Products

  16. Manufacturing Transportation

  17. Healthcare – Out Sample

  18. Communications – Out Sample

  19. Consumer – Out Sample

  20. Manufacturing – Out Sample

  21. Transportation – Out Sample

  22. Optimization

  23. Optimization Value Weighted Equal Weighted

  24. Conclusions • Intra-sector excess returns appear to be consistently available • Inconsistent “in-sample” and “out-of-sample” results within certain industry sectors • Additional analysis should lead to effective factors which could consistently produce intra-sector excess returns

  25. Next Steps • Develop and evaluate additional factors which isolate industry specific excess returns • Test additional industry sectors and sub-sectors in-sample • Vary factors weights across industries • Evaluate migration of stocks within fractiles • Develop and evaluate sector-specific, and overall, trading strategies as part of an overall hedge fund charter

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