An Improved Test for Statistical Arbitrage

• Main Authors: JARROW, Robert, TEO, Melvyn, TSE, Yiu Kuen, WARACHKA, Mitch
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2012
• Subjects: Bootstrap; Momentum strategy; Statistical arbitrage; Value strategy; Corporate Finance; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/2966; https://ink.library.smu.edu.sg/context/lkcsb_research/article/3965/viewcontent/ImprovedTestStatisticalArbitrage_2012.pdf
• Institution: Singapore Management University

We improve upon the power of the statistical arbitrage test in Hogan, Jarrow, Teo, and Warachka (2004). Our methodology also allows for the evaluation of return anomalies under weaker assumptions. We then compare strategies based on their convergence rates to arbitrage and identify strategies whose probability of a loss declines to zero most rapidly. These strategies are preferred by investors with finite horizons or limited capital. After controlling for market frictions and examining convergence rates to arbitrage, we find that momentum and value strategies offer the most desirable trading opportunities.