82,964
edits
Statistical arbitrage: Difference between revisions
no edit summary
Amwelladmin (talk | contribs) No edit summary |
Amwelladmin (talk | contribs) No edit summary |
||
| Line 3: | Line 3: | ||
When it works, it works a charm: the top ranking stat arb hedge funds make extraordinary returns, especially when they drive hard bargains with their [[prime broker]]s to secure cheap, committed funding. When it doesn’t work it can be a disaster, as the Nobel laureates and masters of the universe who founded [[Long Term Capital Management]], and then promptly blew it up, after the unseemly short term of four-and-a-half years. | When it works, it works a charm: the top ranking stat arb hedge funds make extraordinary returns, especially when they drive hard bargains with their [[prime broker]]s to secure cheap, committed funding. When it doesn’t work it can be a disaster, as the Nobel laureates and masters of the universe who founded [[Long Term Capital Management]], and then promptly blew it up, after the unseemly short term of four-and-a-half years. | ||
Say you have spotted that because the most recently-issued (“on-the-run”) 10-year US Treasuries are used as a reference point for various benchmarks, and tend to be in hot demand for hedging and whatnot, while “off-the-run” Treasury bonds issued a couple of months ago — that were on-the-run until these fresh ones were issued — are in less demand and therefore trade at a bit of a discount. Presuming the unimpeachable full faith and credit of the United States Government, you know two things with relative certainty: One that the on the run bonds will, in short order, become off-the-run ones, and suffer the same sudden, jarring lack of popularity, and two, that both will, in a decade’s time, pay exactly the same amount of money.<ref>The three-month difference in tenor is [[priced in]] and does not count as part of the arbitrage, by the way). Therefore selling (going “[[short]]”) the on-the-run bond, and buying (going “long”) the off-the-run bond, will capture that arbitrage in fairly, er, ''short'' order. This trade was a favourite of the most infamous stat arb firm in history, [[Short-Term Capital Demolition]]. | Say you have spotted that because the most recently-issued (“on-the-run”) 10-year US Treasuries are used as a reference point for various benchmarks, and tend to be in hot demand for hedging and whatnot, while “off-the-run” Treasury bonds issued a couple of months ago — that were on-the-run until these fresh ones were issued — are in less demand and therefore trade at a bit of a discount. Presuming the unimpeachable full faith and credit of the United States Government, you know two things with relative certainty: One that the on the run bonds will, in short order, become off-the-run ones, and suffer the same sudden, jarring lack of popularity, and two, that both will, in a decade’s time, pay exactly the same amount of money.<ref>The three-month difference in tenor is [[priced in]] and does not count as part of the arbitrage, by the way).</ref> Therefore selling (going “[[short]]”) the on-the-run bond, and buying (going “long”) the off-the-run bond, will capture that arbitrage in fairly, er, ''short'' order. This trade was a favourite of the most infamous stat arb firm in history, [[Short-Term Capital Demolition]]. | ||
Another one is to pick a bunch of securities in the same sector, that have basically the same attributes, and making a quantitative decision among them which is overvalued — likely to underperform — and which is undervalued — likely to outperform, and shorting the former and buying the latter. Assuming the sector is going gangbusters, your performance will track it, but should improve on it, as this arbitrage works itself out. | Another one is to pick a bunch of securities in the same sector, that have basically the same attributes, and making a quantitative decision among them which is overvalued — likely to underperform — and which is undervalued — likely to outperform, and shorting the former and buying the latter. Assuming the sector is going gangbusters, your performance will track it, but should improve on it, as this arbitrage works itself out. | ||
| Line 17: | Line 17: | ||
*[[Hedge fund]]s | *[[Hedge fund]]s | ||
{{C|Investment Strategies}} | {{C|Investment Strategies}} | ||
{{ref}} | |||