Selecting macro factors for trading strategies

September 17, 2016

A powerful statistical method for selecting macro factors for trading strategies is the “Elastic Net”. The method simultaneously selects factors in accordance with their past predictive power and estimates their influence conservatively in order to contain the influence of accidental correlation. Unlike other statistical selection methods, such as “LASSO”, the “Elastic Net” can make use of a large number of correlated factors, a typical feature of economic time series.

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Mutual fund flows and fire sale risk

September 10, 2016

A new empirical paper looks at the drivers of U.S. mutual funds flows across asset classes. An important finding is that changes of monetary policy expectations towards tightening trigger net outflows from bond funds and net inflows into equity funds. Typically, the costs of redemptions are borne by investors that do not redeem or redeem late. This creates incentives for fire sales and causes of price distortions, particularly if the outlook for monetary policy is revised significantly.

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Corporate bond market momentum: a model

September 3, 2016

An increase in expected default ratios naturally reduces prices for corporate bonds. However, it also triggers feedback loops. First, it reduces funds’ wealth and demand for corporate credit in terms of notional, resulting in selling for rebalancing purposes. Second, negative performance of funds typically triggers investor outflows, resulting in selling for redemption purposes. Flow-sensitive market-making and momentum trading can aggravate these price dynamics. A larger market share of passive funds can increase tail risks.

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The importance of differentiating types of oil price shocks

August 13, 2016

To assess the consequences of an oil price shock for markets it is important to identify its type. A new method separates oil supply shocks, oil market-specific demand shocks and global growth shocks. Supply shocks have accounted for about 50% of price volatility since the mid-1980s. Oil market-specific shocks drive a wedge between the growth of developed and emerging economies and hence matter for exchange rate trends. Global demand shocks to oil prices do not cause such a divergence.

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Fed policy shocks and foreign currency risk premia

August 5, 2016

A new Federal Reserve paper suggests that non-conventional monetary policy easing “shocks” not only push foreign currencies higher versus the U.S. dollar, but also reduce the risk premia on foreign-currency cash and bonds. Non-conventional easing shifts the options-implied skewness of risk from dollar appreciation to depreciation, due partly to diminishing U.S. dollar funding pressure. The effects appear to be temporary, though.

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Sticky expectations and predictable equity returns

July 23, 2016

New research documents that company earnings expectations of analysts have historically been sticky, plausibly reflecting that it takes time and effort to update forecasts. Such stickiness can explain two important anomalies of stock returns: price momentum and outperformance of high-profitability stocks. Indeed, these two anomalies have been correlated and stronger for stocks where analyst expectations have been stickier.

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Trend following as tail risk hedge

July 18, 2016

Typical returns of a trend following strategy carry features of a “long vol” position and have positive convexity. Typical returns of long only strategies, such as risk parity, rather exhibit a “short vol” profile and negative convexity. This makes trend following a useful complement of long-only portfolios, by mitigating tail risks that manifest as escalating trends. Options are naturally a cleaner hedge for tail risk, but have over the past two decades been prohibitively expensive.

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The illiquidity risk premium

July 16, 2016

The illiquidity risk premium is an excess return paid to investors for tying up capital. The premium compensates the investor for forfeiting the options to contain mark-to-market losses and to adapt positions to a changing environment. A brief paper by Willis Towers Watson presents an approach to measure the illiquidity risk premium across assets. The premium appears to be time-variant and highest during and pursuant to financial crises.

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FX strategies based on real exchange rates

July 9, 2016

New empirical research provides guidance as to how to use real exchange rates for currency strategies. First, real exchange rates can serve as a basis for value-based strategies, but only if they are adjusted for key secular structural factors, such as productivity growth and product quality. Second, real exchange rates in conjunction with macroeconomic indicators can serve as indicators for the risk premia paid on currency positions.

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The 1×1 of trend-following

July 2, 2016

Trend-following is the dominant alternative investment strategy. Its historical return profile has been attractive on its own and for diversification purposes. It is suitable for rising and falling prices, albeit not for range-bound and “gapping” markets. A basic trend-following algorithm is easy to build. Trend-following commands over USD300 billion in dedicated assets and a lot more are managed by informal trend-followers. The style is itself a major force of price trends, with no direct ties to fundamental asset value.

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Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.

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