Information about Statistical Arbitrage
Statistical arbitrage, or StatArb, as opposed to (deterministic) arbitrage, is related to the statistical mispricing of one or more assets based on the expected value of these assets. For example, consider a game in which one flips a coin and collects $1 on heads or pays $0.50 on tails. In any single flip it is uncertain if one will win or lose money. However, in the statistical sense, there is an expected value of $1×50% − $0.50×50% = $0.25 for each flip. According to the law of large numbers, the mean return on actual flips will approach this expected value as the number of flips increases. This is precisely the way in which a gambling casino makes a profit. In other words, statistical arbitrage conjectures statistical mispricings or price relationships that are true in expectation, in the long run when repeating a trading strategy.
In recent years, there has been a trend away from simple pair-trading, and now it is more common for portfolios of stocks to be 'clustered' by sector and region in offsetting any beta exposure. After the portfolio is constructed in this manner, it is usually optimized using risk models like Barra/APT/EMA/Northfield to constrain or eliminate various risk factors..
Stat Arb is actually any strategy that is bottom-up, beta-neutral in approach and uses statistical/econometric techniques in order to provide signals for execution. Signals are often generated through a contrarian mean-reversion principle, but can also be formed by extreme psychological barriers, corporate activity, as well as short-term momentum. Clearly, this technique only is demonstrably correct as the amount of trading time approaches infinity, or alternately, it does not take into consideration what is typically called "gambler's ruin."
Statistical arbitrage has become a major force at both hedge funds and investment banks. Many bank proprietary operations now center to varying degrees around statistical arbitrage trading.
Volatility arbitrage is a form of statistical arbitrage in which options, rather than equities, are the primary vehicle of the strategy.
The statistical relationship on which the model is based may be spurious, or may break down due to changes in the distribution of returns on the underlying assets. Factors which the model may not be aware of having exposure to, could become the significant drivers of price action in the markets, and the inverse applies also.
On a stock-specific level, there is risk of M&A activity or even default for an individual name. Such an event would immediately end any historical relationship assumed from empirical statistical analysis.
Trading strategy
As a trading strategy, statistical arbitrage is a heavily quantitative and computational approach to equity trading. It describes a variety of automated trading systems which commonly make use of data mining, statistical methods and artificial intelligence techniques. A popular strategy is pairs trade, in which stocks are put into pairs by fundamental or market-based similarities. When one stock in a pair outperforms the other, the poorer performing stock is bought long with the expectation that it will climb towards its outperforming partner, the other is sold short. This hedges risk from whole-market movements.In recent years, there has been a trend away from simple pair-trading, and now it is more common for portfolios of stocks to be 'clustered' by sector and region in offsetting any beta exposure. After the portfolio is constructed in this manner, it is usually optimized using risk models like Barra/APT/EMA/Northfield to constrain or eliminate various risk factors..
Stat Arb is actually any strategy that is bottom-up, beta-neutral in approach and uses statistical/econometric techniques in order to provide signals for execution. Signals are often generated through a contrarian mean-reversion principle, but can also be formed by extreme psychological barriers, corporate activity, as well as short-term momentum. Clearly, this technique only is demonstrably correct as the amount of trading time approaches infinity, or alternately, it does not take into consideration what is typically called "gambler's ruin."
Statistical arbitrage has become a major force at both hedge funds and investment banks. Many bank proprietary operations now center to varying degrees around statistical arbitrage trading.
Volatility arbitrage is a form of statistical arbitrage in which options, rather than equities, are the primary vehicle of the strategy.
Risks
Statistical arbitrage is subject to model weakness as well as stock-specific risk.The statistical relationship on which the model is based may be spurious, or may break down due to changes in the distribution of returns on the underlying assets. Factors which the model may not be aware of having exposure to, could become the significant drivers of price action in the markets, and the inverse applies also.
On a stock-specific level, there is risk of M&A activity or even default for an individual name. Such an event would immediately end any historical relationship assumed from empirical statistical analysis.
See also
- Arbitrage
- Currency correlation
- Volatility arbitrage
In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices.
..... Click the link for more information.
..... Click the link for more information.
expected value (or mathematical expectation, or mean) of a discrete random variable is the sum of the probability of each possible outcome of the experiment multiplied by the outcome value (or payoff).
..... Click the link for more information.
..... Click the link for more information.
The law of large numbers (LLN) is a theorem in probability that describes the long-term stability of a random variable. Given a sample of independent and identically distributed random variables with a finite population mean and variance, the average of these observations will
..... Click the link for more information.
..... Click the link for more information.
gambling has had many different meanings depending on the cultural and historical context in which it is used. Currently, in Western societies, it has an economic definition, referring to "wagering money or something of material value on an event with an uncertain outcome with the
..... Click the link for more information.
..... Click the link for more information.
casino is a facility that accommodates certain types of gambling activities. Casinos are often placed near or combined with hotels, restaurants, retail shopping, cruise ships and other vacation attractions.
..... Click the link for more information.
..... Click the link for more information.
In finance, equity trading is the buying and selling of company stock shares. Shares in large publicly-traded companies are bought and sold through one of the major stock exchanges, such as the New York Stock Exchange, London Stock Exchange or Tokyo Stock Exchange, which serve as
..... Click the link for more information.
..... Click the link for more information.
Data mining can be defined as "the nontrivial extraction of implicit, previously unknown, and potentially useful information from data".[1] Data mining may also be defined as "the science of extracting useful information from large data sets or databases".
..... Click the link for more information.
..... Click the link for more information.
artificial intelligence (or AI) is "the study and design of intelligent agents" where an intelligent agent is a system that perceives its environment and takes actions which maximizes its chances of success.
..... Click the link for more information.
..... Click the link for more information.
The pairs trade was developed in the late 1980s by quantitative analysts. They found that certain securities, often competitors in the same sector, were correlated in their day-to-day price movements. When the correlation broke down, i.e.
..... Click the link for more information.
..... Click the link for more information.
Stocks are devices used since medieval times for public humiliation, corporal punishment, and torture. The stocks are similar to the pillory and the pranger, as each consists of large, hinged, wooden boards; the difference, however, is that when a person is placed in the stocks,
..... Click the link for more information.
..... Click the link for more information.
In finance, a long position in a security, such as a stock or a bond, or equivalently to be long a security, means the holder of the position owns the security and will profit if the price of the security goes up.
..... Click the link for more information.
..... Click the link for more information.
In finance, short selling or "shorting" is a way to profit from the decline in price of a security, such as a stock or a bond. In contrast, investors who "go long" with an investment hope the price will rise.
..... Click the link for more information.
..... Click the link for more information.
Beta coefficient, in terms of finance and investing, is a measure of a stock (or portfolio)’s volatility in relation to the rest of the market. Beta is calculated for individual companies using regression analysis.
..... Click the link for more information.
..... Click the link for more information.
The basic meaning of gambler's ruin is a gambler's loss of the last of his bank of gambling money and consequent inability to continue gambling. In probability theory, the term sometimes refers to the fact that a gambler will almost certainly go broke in the long run against
..... Click the link for more information.
..... Click the link for more information.
Volatility arbitrage (or vol arb) is a type of statistical arbitrage that is implemented by trading a delta neutral portfolio of an option and its underlier. The objective is to take advantage of differences between the implied volatility of the option, and a forecast of future
..... Click the link for more information.
..... Click the link for more information.
Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security. For example, buying a call option provides the right to buy a specified quantity of a security at a set strike price at some time on or
..... Click the link for more information.
..... Click the link for more information.
In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices.
..... Click the link for more information.
..... Click the link for more information.
Volatility arbitrage (or vol arb) is a type of statistical arbitrage that is implemented by trading a delta neutral portfolio of an option and its underlier. The objective is to take advantage of differences between the implied volatility of the option, and a forecast of future
..... Click the link for more information.
..... Click the link for more information.
This article is copied from an article on Wikipedia.org - the free encyclopedia created and edited by online user community. The text was not checked or edited by anyone on our staff. Although the vast majority of the wikipedia encyclopedia articles provide accurate and timely information please do not assume the accuracy of any particular article. This article is distributed under the terms of GNU Free Documentation License.
Herod_Archelaus
