Statistical arbitrage in the US equities market

Marco Avellaneda, Jeong Hyun Lee

Research output: Contribution to journalArticle

Abstract

We study model-driven statistical arbitrage in US equities. Trading signals are generated in two ways: using Principal Component Analysis (PCA) or regressing stock returns on sector Exchange Traded Funds (ETFs). In both cases, the idiosyncratic returns are modelled as mean-reverting processes, which leads naturally to 'contrarian' strategies. We construct, back-test and compare market-neutral PCA- and ETF-based strategies applied to the broad universe of US equities. After accounting for transaction costs, PCA-based strategies have an average annual Sharpe ratio of 1.44 over the period 1997 to 2007, with stronger performances prior to 2003. During 2003-2007, the average Sharpe ratio of PCA-based strategies was only 0.9. ETF-based strategies had a Sharpe ratio of 1.1 from 1997 to 2007, experiencing a similar degradation since 2002. We also propose signals that account for trading volume, observing significant improvement in performance in the case of ETF-based signals. ETF-strategies with volume information achieved a Sharpe ratio of 1.51 from 2003 to 2007. The paper also relates the performance of mean-reversion statistical arbitrage strategies with the stock market cycle. In particular, we study in detail the performance of the strategies during the liquidity crisis of the summer of 2007, following Khandani and Lo [Social Science Research Network (SSRN) working paper, 2007].

Original languageEnglish (US)
Pages (from-to)761-782
Number of pages22
JournalQuantitative Finance
Volume10
Issue number7
DOIs
StatePublished - 2010

Fingerprint

Statistical arbitrage
Equity markets
Exchange traded funds
Sharpe ratio
Principal component analysis
Equity
Degradation
Stock market
Liquidity crisis
Contrarian strategy
Trading volume
Social sciences
Research networks
Mean reversion
Stock returns
Transaction costs
Mean-reverting process

Keywords

  • Alternative investments
  • Cointegration
  • Correlation modelling
  • Quantitative trading strategies

ASJC Scopus subject areas

  • Economics, Econometrics and Finance(all)
  • Finance

Cite this

Statistical arbitrage in the US equities market. / Avellaneda, Marco; Lee, Jeong Hyun.

In: Quantitative Finance, Vol. 10, No. 7, 2010, p. 761-782.

Research output: Contribution to journalArticle

Avellaneda, Marco ; Lee, Jeong Hyun. / Statistical arbitrage in the US equities market. In: Quantitative Finance. 2010 ; Vol. 10, No. 7. pp. 761-782.
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