Why and how systematic strategies decay

In this paper, we propose ex-ante characteristics that predict the drop in risk-adjusted performance out-of-sample for a large set of stock anomalies published in finance and accounting academic journals. Our set of predictors is generated by hypotheses of OOS decay put forward by McLean and Pontiff...

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Bibliographic Details
Published in:arXiv.org 2021-05
Main Authors: Falck, Antoine, Rej, Adam, Thesmar, David
Format: Article
Language:English
Subjects:
Accounting
Anomalies
Arbitrage
Decay
Hypotheses
Hypothesis testing
Mathematical analysis
Outliers (statistics)
Online Access:Get full text
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Summary:In this paper, we propose ex-ante characteristics that predict the drop in risk-adjusted performance out-of-sample for a large set of stock anomalies published in finance and accounting academic journals. Our set of predictors is generated by hypotheses of OOS decay put forward by McLean and Pontiff (2016): arbitrage capital flowing into newly published strategies and in-sample overfitting linked to multiple hypothesis testing. The year of publication alone - compatible with both hypotheses - explains 30% of the variance of Sharpe decay across factors: Every year, the Sharpe decay of newly-published factors increases by 5ppt. The other important variables are directly related to overfitting: the number of operations required to calculate the signal and two measures of sensitivity of in-sample Sharpe to outliers together add another 15% of explanatory power. Some arbitrage-related variables are statistically significant, but their predictive power is marginal.
ISSN:2331-8422