John Paul Broussard

Profitability of pairs trading strategy in an illiquid market with multiple share classes

We investigate the practical issues of implementing the self-financing pairs portfolio trading strategy presented by Gatev et al. (2006). We also provide new evidence on the profitability of pairs trading under different weighting structures and trade initiation conditions. Using data from the Finnish stock market over the period 1987–2008, we find pairs trading to be profitable even after allowing for a one day delay in the trade initiation after the signal. On average, the annualized return can be as high as 12.5%, though requiring trading on days a pair is traded lowers the return approximately by three percentage points. On the other hand, lowering the threshold for opening a pair is found to increase returns even after accounting for trading costs, indicating that there might be a more optimal trade initiation threshold available than that presented in earlier literature. The profits are not related to market risk. Pairs trading strategy is found to produce positive alpha during the sample period.The profitability of self-financing pairs portfolio trading strategy (Gatev et al., 2006) is studied in the Finnish stock market under different weighting structures. Over the period 1987 to 2004, we find pairs trading to be profitable even after allowing for a one day delay in the trade initiation after the signal. On average, the annualized return can be as high as 15%. The profits are not related to market risk. Fully invested pairs trading strategy is found to produce positive alpha during the sample period.

Extreme-value and margin setting with and without price limits

Abstract Extreme-value statistical techniques have recently been applied to margin setting in futures markets. Price limits, however, may undermine the benefits associated with the extreme-value method. The purpose of this paper is to examine how price limit events impact the extreme-value parameter estimation process. This has yet to be accomplished in the literature. In addition to showing different parameter estimates for data with and without price limits, the results here also document differences in the probabilities of observing large price changes in CBOT corn and T-bond futures contracts. The latter result is especially important to consider in a margin setting context.

Earnings and stock returns: evidence from Germany

Past research in the US indicates that stock prices and earnings per share are related. Evidence pertaining to this relationship in other countries is not as extensive. This paper extends two recent studies focusing on Germany, and provides additional information concerning the important informative role played by DVFA earnings. DVFA earnings are a metric jointly constructed by the Deutscher Vereinigung fur Finanzanalyse und Anlageberatung and the Schmalenbach-Gesellschaftwith the purpose of providing investors and others interested in share value with a more meaningful measure of economic income than the traditional published earnings figure

Setting NYSE Circuit Breaker Triggers

This paper investigates the stochastic behavior of large movements in the Dow Jones Industrial Average and applies the results to estimate the probability that the circuit breaker mechanism employed by the New York Stock Exchange will be activated. This is accomplished using extreme value statistics. In addition, the results confirm the inflexibility of a fixed-point circuit breaker.

Testing the contrarian investment strategy using holding period returns

Reviews previous research on contrarian investment strategy (i.e. buying “losers” and selling “winners”) and analyses the results of applying the strategy to US stocks 1928‐1992. Explains the methodology and presents the results, which show no statistically significant holding period returns from the strategy, although selling the “winners” is significant. Considers the implications and limitations of the study and calls for further research.

Price discovery in German stock and futures markets

Compares the trading efficiency of electronic and open outcry futures markets. Argues that the difference between the German DAX (floor) and FDAX (electronic) markets is due to asset type, not to information processing speed. Describes the German trading environment, comparing trading data from 1992 to 1994. Shows that the returns for DAX are positively skewed and for FDAX negatively skewed and more volatile. From regression and Granger causality tests establishes a feedback relationship between the two markets, in which the spot market is slower to digest information than the futures market. Points out that the dominant DAX stocks are also traded electronically, so the means of trade is not the cause of the difference.

Big players and the Russian rouble: explaining volatility dynamics

Outlines previous research attempts to explain the behaviour of second moments of price and return distributions and theories of how Big Players (i.e. those with enough discretionary power to influence the market but little sensitivity to profit/loss consequences) affect the volatility and informational efficiency of markets. Contrasts the 1883‐1892 fluctuations in the exchange value of the Russian rouble under interventionist (i.e. big player) and non‐interventionist finance ministers; and analyses the statistics using GARCH techniques. Shows that under the Big Player, both unconditional variance and the persistence of conditional volatility increased. Suggests that policy regimes affect the degree of noise‐trader influence and calls for further research.

BANK STOCK RETURNS, INTEREST RATE CHANGES, AND THE REGULATORY ENVIRONMENT: NEW INSIGHTS FROM JAPAN

This paper re-examines the relationship between interest rate changes and bank stock returns using the Japanese experience. Specifically, we test the relationship under two different regulatory regimes. During the first regime (1975–1983), there was strict regulation of the financial system and significant oversight of bank activities, whereas the latter regime (1984–1994) represented a period of financial liberalization and interest rate deregulation. The results presented here indicate that interest rate changes negatively affected Japanese bank equity in the post-regulatory period, but not during the period of heavy regulation. Additionally, we also find that most of the short-term rate effects were channeled through volatility proxies while long-term effects were channeled through yield spread and shape effects. These findings represent new and important insights into the relationship between interest rate changes and bank stock returns.

Human Bias in Algorithmic Trading

This paper documents a stark periodicity in intraday volume and in the number of trades. We find activity in both variables spikes by about 20% at regular intervals of 5 or 10 minutes throughout the trading day. We argue that this activity is the result of algorithmic trading influenced by human traders/programmers’ behavioral bias to transact on round time marks. An alternative explanation, that algorithms choose to concentrate their trades in time to take advantage of lower costs or to protect themselves from better informed traders, is not supported.