How A Mean-Reversion Strategy Performed Inward August

Prof. Andrew Lo in addition to Mr. Amir Khandani at MIT of late wrote a newspaper on "What Happened To The Quants In August 2007?" (Hat tip to my reader Mr. J. Rigg for the article). Most of their conclusions confirm what many observers already suspected: that the loss is probable due to the simultaneous forced liquidation of portfolios belongings similar positions past times diverse quantitative funds. What is noteworthy, however, is that they constructed a mean-reversion strategy in addition to observed what happened to it during August. This strategy is really simple: purchase the stocks amongst the worst previous 1-day returns, in addition to brusk the ones amongst the best previous 1-day returns. Despite its speak simplicity, this strategy has had corking functioning since 1995, ignoring transaction costs. The Sharpe ratio was an astounding 53.87 inwards 1995, gradually decreasing to 4.47 inwards 2006. However, the strategy also had a disastrous few days on August 7-9, suffering a cumulative (arithmetic) furnish of -6.85% inwards those 3 days. Then on August 10, it rebounded, similar the remainder of the quant funds, amongst a furnish of 5.92%, most reversing all of its previous losses. For me, this experiment reveals 3 interesting points: 1) a uncomplicated cost element seems to capture most of the functioning of the complex element models hold out past times the gigantic hedge funds; 2) fifty-fifty technical mean-reverting factors endure losses, non only momentum (growth) factors based on fundamentals; in addition to 3) if i wants to avoid disasters in addition to taste spectacular returns, fifty-fifty a one-day belongings menstruum is besides long. I haven't done the experiment myself yet, but I bet that if nosotros were to liquidate the portfolio at marketplace unopen each day, non alone would nosotros avoid the loss of -6.85% inwards those 3 days, but would in all likelihood cease upwards amongst a positive furnish of a similar magnitude!