...Slow Diffusion of Information and Price Momentum in Stocks: Evidence from Options Markets Zhuo Chen∗ Andrea Lu† September 6, 2014 Abstract This paper investigates the source of price momentum in the equity market using information from options markets. The empirical results provide direct evidence of the gradual information diffusion model in Hong and Stein (1999). Consistent with their theory, we show that a successful identification of stocks’ information diffusion stage helps explain momentum profits. We are able to enhance momentum profits by longing winner stocks with higher growth (and shorting loser stocks with larger drop) in call options implied volatility. Our empirical strategy generates a risk-adjusted alpha of 1.8% per month for a hedged winner-minus-loser portfolio over the 1996–2011 period, during which the simple momentum strategy fails to perform. The results are stronger and clearer if we use call options compared with put options, which are consistent with managers’ tendency to reveal good news and hide bad news. Our results are robust to transaction costs, choice of options’ moneyness, elimination of implied volatility persistence, and choice of options’ time-to-maturity. Finally, our results are not driven by existing stock-level characteristics, such as size, trading volume, and analyst coverage. JEL Classification: G10, G11, G12, G13 Keywords: Momentum, Implied Volatility PBC School of Finance, Tsinghua University. Email: chenzh@pbcsf.tsinghua.edu.cn...
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...Topic：Stock price momentum: Jegadeesh and Titman (1993) Momentum anomaly and EMH Anomaly is a stock return deviation that challenge efficient market hypothesis (EMH). Jegadeesh and Titman (1993) theorise price momentum anomaly in the stock market for the first time. It contradicted to efficient market hypothesis thereby is widely debated. EMH states that no consistent excess return can be achieved since security prices fully reflect all available information (Fama 1970). Therefore, future prices cannot be predicted through technical analysis of past prices. If the hypothesis is true, passive investment strategy ought to be taken, because it is impossible to get abnormal return by aggressive trading. However, Jegadeesh and Titman show that stocks performed well over the previous 3 to 12 months tend to continue to perform well over 3 to 12 months holding periods. Buy past winners and short past losers earned statistically significant positive return of averaging 12.01% per year. Predictable price patterns and excess returns contradict the efficient market hypothesis. Investors and fund managers perform actively in pursuing abnormal profits. Literature review and the reason of anomaly A large number of literatures illustrate that momentum anomaly exist. Some important literatures are Chan, Jegadeesh and Lakonishok (1996), Conrad and Kaul (1998) and Moskowitz and Grinblatt (1999). Lee and Swaminathan (2000) find high past turnover stocks exhibit larger magnitude of momentum but shorter...
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...Competitive Landscape & Beginning Literature Review Introduction The goal of my capstone project, the Simulated Investment Fund and Technology Blindside Strategy, is to develop a simulated investment fund and study particular firms that are part of the investment fund to understand the technology blind-side risks within those firms. A major part of it is to build a successful trading strategy. “In finance, a trading strategy is a fixed plan that is designed to achieve a profitable return by going long or short in markets. The main reasons that a properly researched trading strategy helps are its verifiability, quantifiability, consistency, and objectivity” [1]. Currently we have two trading strategies combined together. The first strategy is called Polynomial Regression Strategy, which uses mathematical method to calculate the high degree polynomial regression line. Based on the trend we could find the signals to buy or sell stocks. The second trading strategy is called Discounted Cash Flow method, which is a part of fundamental analysis strategy. It uses future free cash flow to discount them back to arrive at a present value, which is used to evaluate the attractiveness for a potential investment. However, there are so many different strategies in the world except for what we are working on right now. The most popular five trading strategies are as following: Mean Reversion In the world of technology analysis, moving average is one of the most popular and widely used indicators. What...
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...price momentum: Jegadeesh and Titman (1993) Momentum anomaly and EMH Anomaly is a stock return deviation that challenge efficient market hypothesis (EMH). Jegadeesh and Titman (1993) theorise price momentum anomaly in the stock market for the first time. It contradicted to efficient market hypothesis thereby is widely debated. EMH states that no consistent excess return can be achieved since security prices fully reflect all available information (Fama 1970). Therefore, future prices cannot be predicted through technical analysis of past prices. If the hypothesis is true, passive investment strategy ought to be taken, because it is impossible to get abnormal return by aggressive trading. However, Jegadeesh and Titman show that stocks performed well over the previous 3 to 12 months tend to continue to perform well over 3 to 12 months holding periods. Buy past winners and short past losers earned statistically significant positive return of averaging 12.01% per year. Predictable price patterns and excess returns contradict the efficient market hypothesis. Investors and fund managers perform actively in pursuing abnormal profits. Literature review and the reason of anomaly A large number of literatures illustrate that momentum anomaly exist. Some important literatures are Chan, Jegadeesh and Lakonishok (1996), Conrad and Kaul (1998) and Moskowitz and Grinblatt (1999). Lee and Swaminathan (2000) find high past turnover stocks exhibit larger magnitude of momentum but shorter...
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...Investigating Momentum on the Johannesburg Stock Exchange December 1 2010 Hendrik Snyman 14422425 A dissertation submitted in partial fulfilment of the requirements for the degree of Master of Science in Engineering (Management) Department of Industrial Engineering University of Stellenbosch An oil prospector had died and gone to heaven. At the gate, he is met by St Peter.‘Well, I checked you out and you meet all of the qualifications. But there’s one problem,’ He said. ‘We have some tough zoning laws up here, and we keep all of our oil prospectors over in that pen. And as you can see, it is absolutely chock-full. There is no room for you.’ And the prospector said, ’Do you mind if I just say four words?’ St Peter said, ‘No harm in that.’ So the prospector cupped his hands and yelled out, ‘Oil discovered in hell!’ And, of course, the lock comes off the cage and all of the oil prospectors start heading straight down. St Peter said, ‘That’s a pretty sick trick. So,‘ he says, ’go in and make yourself at home. All the room in the world.’ The prospector paused for a minute, then said, ‘No, I think I’ll go along with the rest of the boys. There might be some truth to that rumour after all.’ 1 1 Janet Lowe, The Rediscovered Benjamin Graham: Selected Writings of the Wall Street Legend, Wiley, 1999. I|Page Dedication This dissertation is dedicated to all those people who provided moral and financial support along with particular insight into the weird and wonderful...
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...MxN strategy Here, we specifically use a strategy that selects stocks on the basis of returns over the past M months (i.e. formation period) and holds them for N months (holding period). This is called as the M x N strategy. At the beginning of each month t, the candidate stocks are ranked in descending order on the basis of their returns in the past M months. The top decile portfolio is called the “winners” portfolio and the bottom decile is called the “losers” portfolio. This strategy involves, simultaneously buying the winner portfolio and selling the loser portfolio and then holding this position for N months (total number of months). The strategies we have considered in our project involve selecting stocks based on their 3-month and 6month returns (for formation period). We then consider holding periods of 3, 6 and 12 months for stocks selected on the basis of returns in 3-month formation period--thus generating trading strategies: 3x3, 3x6 and 3x12. On the basis of returns in 6-month formation period, however, we consider a holding period of only 12 months, thus generating the 6x12 trading strategy. However in the project report analysis of only 6x12 strategy is laid down due to non-completion of other strategies. Methodology In this paper, we explain the methodology for 6 x 12 strategy for illustration purpose, although similar methodology has been used in other strategies as well. The analysis is performed using first six months data for portfolio formation...
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...TRADING EXERCISE REPORT ASSET CLASS: FIXED INCOME FUTURES GROUP: Bakhali, Cordero, Gunkel, Swaleh, Quevedo PRELIMINARY STRATEGY REPORT OCTOBER 17, 2012 _______________________________________________________________________________ -(5-10 pages) explaining the various trading strategies you will use :I am just interested to learn about what you plan to try during the next weeks. - The report will be worth 10 points. The grading will be based on the following questions: • Do you understanding how your asset class works? (5 pts) • Did you define clearly and unambiguously your trading strategy? (5 pts) • The key for us is to try to forecast the interest rate for which we need to analyze the impact of monetary policy and QE3, among others. I. Introduction: 1. Asset Selection Eurodollar futures: traded at Chicago Mercantile Exchange (CME Globex Electronic trading platform); convey obligations over a specific notional $ amount in a specific currency $1 million investors use futures to target a cash rate of interest on an underlying benchmark cash product Short term interest rate futures: 3 months Settling price on an exact point in time, when rate of underlying is fixed, the price of cash is agreed upon or fixed every day to create LIBOR settlements (London Interbank offered rate), which is the daily fixing by member banks around London @ 11 am each day. 2. Attributes of Eurodollar Futures: Underlying Instrument | 3-month LIBOR: LIBOR on 3-month U.S.$ deposits...
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...Overview Momentum is a phenomenon shows that well-performed stocks continue to outperform their peers while poor-performed stocks continue to underperform. Thus, more mutual funds use this powerful strategy to draw a broad range of investors by getting higher risk-adjusted returns. AQR is a hedge fund based in Greenwich, Connecticut, offering investing products that applies price phenomenon known as momentum. This case study enables investors to get a closer look at AQR’s momentum fund. Comparison of momentum specifications In order to analyze the momentum effect of different specifications, stocks were divided into ‘winner’ stocks and ‘loser’ stocks according to their rankings. From the data we can see that the decile spread portfolio return is the highest among these momentum specifications. One may argue that the spread between decile 10 and decile 1 is largest and it also has the highest volatility. After adjusting for volatility (using Sharpe Ratio), the decile spread momentum advantage is reduced but still very significant. According to Figure 1.1 and 1.2, raw spread returns witness a sharp decrease as the chosen percentile of highest and lowest stock return increases. After adjusted by volatility, the difference becomes flatter but still significant. From the graphs we can see that the volatility-adjusted return of decile spread is higher than the UMD spread, which means buying top 10% winner stocks and shorting bottom 10% loser stocks earns more profit than buying...
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...managers have shown a keen interest in earning excess returns through different trading strategies. There has been a long debate whether financial markets are efficient or not, especially in the Indian context. If markets are efficient, there will not arise any arbitrage opportunities to take advantage of mispricing of securities. This paper intends to find out whether is it possible to earn excess returns in the Indian market by using any trading strategy and if it is possible, then which strategy is better. We take 30 companies out of 50 belonging to CNX Nifty and through data from Jan’2000-July’2014; we try to find whether one can earn excess returns from the market in the long run. We use Capital Asset Pricing Model (CAPM) to test for excess returns. The variable of our interest is the alpha or the intercept term while applying regression as stated under the CAPM model. For this, we take the return on the CNX Nifty Index as return on the market and the yield on 91-Day T-Bills as a proxy for the risk free rate. Our results show that the alpha is significant and we are able to generate excess return of 1.47% through momentum strategy and excess return of 0.74% through contrarian strategy. This also shows that momentum strategy is better in the long run than contrarian strategy in the context of Indian market. References Antoniou A.; Lam, H.Y.T; Paudyal, K.(2007). Profitability of momentum strategies in international markets: The role of business cycle variables and behavioral...
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...technical analysis tools play an important role for the security evaluation. According to Penman (2010), investors estimate the stock future prices and trends by collecting and estimate the past prices and information. However, there are some conflict points on the momentum strategies performance, and it is a technical tool with multiple economy factors needs to be considered into. Why do momentum strategies exist? Refer to both behavioural and market-based argumentations. Momentum strategies are the stock analysis stool exists in the financial evaluation process, also in funds and currency investment. According to Chan, Jegadeesh, and Lakonishok J (1996) said, "it is a strategy that buying stocks in a high returns over the past three to twelve months, and selling those that had the poor returns over the same period." In the other words, the outperform stock will remain well but the underperform stock will continually worse (Fama & French, 1992). From the views from market- based argumentation, massive of evidence find that the momentum strategies are profitable for financial investment. For example, Aharoni, Ho and Zeng (2012) had a test in the profitability of momentum strategies in Australia stock market, which be found that the...
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...investment strategy? What is its rationale for Numeric? Ans. Numeric managed tax-exempt accounts for pension funds and endowments and funds of funds taxable accounts. Firm managed different funds across seven product categories. Five of the product categories involved long-only strategies whereas rest two categories involved long/short strategies. Long/Short involved holding a portfolio of long positions with a portfolio in short positions. The strategy used is “double alpha” in which both winners and losers are predicted. The advantage in this was that it was able to give higher returns as it used both positive and negative information in the market to its advantage. Numeric’s investment strategies were: 1. Long only - strategy where products are: a. Core Aggressive b. Small Cap growth c. Midcap aggressive d. Microcap e. Value aggressive 2. Long / Short strategy without equitization 3. Long / Short strategy with equitization – having long/short market neutral portfolio with equal dollar value of stock index futures The bottom-up selection was done on the basis indigenously build stock selection models. The focusing was more on getting performance fees rather than fixed component. Due to this, Numeric only invested fixed amount in a particular strategy which it can profitably invest. Because of the confidence in its investment models, Numeric mostly depended upon word of mouth rather than Marketing. Q2 - What is the difference between long only and long/short strategies? Do they...
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...Review 4 Types of Equity Markets 4 Dark Pool 5 News 5 HFT High frequency trading – grown to account for 20-30% of the volume on the exchanges. Low – latency hardware strategically placed as close as possible to exchange data centers. HFT – defined by trading where speed matters. Subset of HFT by TMX program – ELP (electronic liquidity provider) Today, typical high frequency systems are interpreting and reacting to market data in microseconds. High Frequency Group | Specific Strategy | Market making | *passive rebate arbitrage, exchanges provide incentives to liquidity providers by paying for passive order flowHigh frequency trading strategies that involves placing an order to sell (or offer) or buy a limit order (or bid) in order to earn a bid-ask spread. | | Ticker tape trading – by observing flow of quotes, high frequency machines are able to extract information that has not yet crossed the news screens. Since all quote and volume information is public, fully complaint with regulatory laws | Latency Arbitrage | Interlisted arbitrage – strategy that attempts to buy and sell the same security btw. domiciles. Eg. buying Potash corp in Canada and selling it in the U.S.Intra-listed arbitrage – strategy that attempts to buy and sell the same security btw. domestic marketplaces. Eg. Buying POT on BATS and selling it on NYSE | Information Arbitrage | Index arbitrage – strategy that attempts to profit from mispricing btw. the various forms of a tradable index...
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...Submitted: | 06.04.2014 | Content Tables III Figures III Abbreviations IV 1 Overview of Hedge Funds Strategies 1 2 What are Emerging Markets and why are they so important? 2 3 Why do Hedge Funds invest in Emerging Markets 6 4 DWS Invest Global EM Equities LC 8 4.1 Inside the DWS Invest Global EM Equities LC fund 8 4.2 Performance of the fund 10 5 Hedge Funds Performance in EM scientific paper review 11 6 Hedge Funds Strategies in EM and Africa 12 6.1 Investment strategies in more developed EM. 16 6.2 Hedge Fund Strategies within Africa and Sub Saharan Africa 19 7 Risk exposures in emerging markets 23 8 Conclusion 25 References 26 Tables Table 1: Hedge Fund Strategies 1 Figures Figure 1: Emerging Markets vs. Developed Markets 2 Figure 2: Emerging Markets vs. Developed Markets GDP growth in percentage 3 Figure 3: Development of the working-age population 3 Figure 4: EM vs. US: Consumption levels 4 Figure 5: EM dept. has exceeded EM 5 Figure 6: MSCI World vs. MSCI Emerging Markets 6 Figure 7: CS Hedge Fund Index vs CS EM Hedge Fund Index 7 Figure 8: Country distribution 8 Figure 9: Industry Sectors 9 Figure 10: Equity Share Distribution 9 Figure 11: Perfomanc of the fund 10 Figure 12: EM performance 13 Figure 13: Performance of EM 14 Figure 14: Hedge Fund Strategies in Africa 17 Figure 15: Hedge Fund Strategies in Asian-pacific region 17 Figure 16: Brazil Asset Class Performance 19 Figure 17: Russia and Eastern...
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... 1 Introduction Behavioural finance is the study of the influence of psychology on the behaviour of financial practitioners and the subsequent effect on markets. Behavioural finance is of interest because it helps explain why and how markets might be inefficient. For more information on behavioural finance, see Sewell (2001). 2 History Back in 1896, Gustave le Bon wrote The Crowd: A Study of the Popular Mind, one of the greatest and most influential books of social psychology ever written (le Bon 1896). Selden (1912) wrote Psychology of the Stock Market. He based the book ‘upon the belief that the movements of prices on the exchanges are dependent to a very considerable degree on the mental attitude of the investing and trading public’. In 1956 the US psychologist Leon Festinger introduced a new concept in social psychology: the theory of cognitive dissonance (Festinger, Riecken and Schachter 1956). When two simultaneously held cognitions are inconsistent, this will produce a state of cognitive dissonance. Because the experience of dissonance is unpleasant, the person will strive to reduce it by changing their beliefs. Pratt (1964) considers utility functions, risk aversion and also risks considered as a proportion of total assets. Tversky and Kahneman (1973) introduced the availability heuristic: ‘a judgmental heuristic in which a person evaluates the frequency of classes or the probability of events by availability, i.e. by the ease with which relevant...
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...heuristics. 1 Introduction Behavioural finance is the study of the influence of psychology on the behaviour of financial practitioners and the subsequent effect on markets. Behavioural finance is of interest because it helps explain why and how markets might be inefficient. For more information on behavioural finance, see Sewell (2001). 2 History Back in 1896, Gustave le Bon wrote The Crowd: A Study of the Popular Mind, one of the greatest and most influential books of social psychology ever written (le Bon 1896). Selden (1912) wrote Psychology of the Stock Market. He based the book ‘upon the belief that the movements of prices on the exchanges are dependent to a very considerable degree on the mental attitude of the investing and trading public’. In 1956 the US psychologist Leon Festinger introduced a new concept in social psychology: the theory of cognitive dissonance (Festinger, Riecken and Schachter 1956). When two simultaneously held cognitions are inconsistent, this will produce a state of cognitive dissonance. Because the experience of dissonance is unpleasant, the person will strive to reduce it by changing their beliefs. Pratt (1964) considers utility functions, risk aversion and also risks considered as a proportion of total assets. Tversky and Kahneman (1973) introduced the availability heuristic: ‘a judgmental heuristic in which a person evaluates the frequency of classes or the probability of events by availability, i.e. by the ease with which relevant instances...
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