A University of York paper suggests that equity strategies based on fundamentals and strategies based on momentum are complementary. Thus, relative momentum seems to be a useful overlay for earnings growth-oriented portfolios (probably detecting when high growth companies hit a snag). And trend following has historically reduced volatility and drawdowns of both value and growth strategies.
A new academic paper asserts strong empirical evidence for capital flow deflection: one country’s capital inflow restrictions re-direct capital flows to other countries with similar economic characteristics. While the paper investigates from a policymaker angle, it would be relevant for international macro trading strategies.
An updated paper by Adam, Beutel, and Marcet claims that booms and busts in U.S. stock prices can be explained by investors’ subjective capital gains expectations. Survey measures of these expectations display excessive optimism at market peaks and excessive pessimism at market troughs.
This post briefly summarizes why markets are struggling to price macroeconomic trends efficiently. The summary is identical to this blog’s page “Systematic Value III: Information Efficient Tracking of Macro Trends”, which is subject to continuous updates.
A theoretical Bank of Japan paper suggests that instability and herding in bond markets arises from low overall confidence of investors, great importance of public information (such as central bank announcements), and high value of privileged information. This analysis goes some way in explaining drastic bond market moves in the age of quantitative easing, such as the 2013 JGB market sell-off.
Conventional wisdom is that markets are information efficient. Alas, a simple game-theoretical model illustrates that value traders only have an incentive to invest in research and information if (i) information cost is low enough, (ii) the overall market is sufficiently clueless, and (iii) market makers do not suspect value traders of being well informed. This leaves ample scope for the overall market to remain inefficient, even in the long run, with undesirable consequences for society as a whole.
Large foreign exchange interventions are common in emerging markets, typically in response to capital flows. What is less well understood is the expansionary (contractionary) impact of FX purchases (sales) on local credit, even if the transactions are sterilized. Sterilization securities mostly end up on banks’ balance sheets, where they function as substitutes for bank reserves, serve as collateral, and encourage banks to expand their loans-to-securities ratios.
Daniel Detzer and Hansjoerg Herr deliver a superb summary of timeless economic theories of financial crisis. The main focus is on (i) escalatory inflation and deflation dynamics caused by monetary policy, (ii) boom and bust investment cycles caused by herding and inefficient expectation formation, and (iii) speculative bubbles related to cognitive behaviour that is inconsistent with efficient markets.
An academic summary paper shows how the structure of commodity markets has changed, most notably through the growth of commodity index investors. This has raised the correlation of commodities with other asset classes. Moreover, this financialization may impair at times the two key functions of commodity markets: risk sharing and price discovery.
Modern physics teaches that objects behave differently as they reach the speed of light. This has become relevant for financial market execution. While prices pretend to be global, in reality they depend on location. Liquidity at any given price is uncertain. And physical location becomes critical for the success of certain trading styles. Moreover, quantum physics suggest that ‘freak events’ that destabilize the markets are likely to occur.
