Monday, March 25, 2013

John Carney — The Secret to SAC's Returns May Be Weirdness

What could make stock arbitrage too costly for certain stocks? Probably the most common thing would be weirdness. When a stock is very weird, when its price doesn't correlate very well with other assets, it becomes costly to develop hedges against positions taken in it. The technical term for this is "idiosyncratic volatility." When a stock behaves as if the rest of the market didn't really exist this means that risk adverse investors will not be willing to exercise efficiency creating pressure on the stock.
A paper published in the Financial Analysts Journal in 2009 explored this strategy. "When is Stock-Picking Likely to be Successful? Evidence from Mutual Funds" found that mutual fund managers exhibit "stock-picking ability for stocks with high idiosyncratic volatility but not for stocks with low idiosyncratic volatility."
Another way to take advantage of idiosyncrasy would be to have the skill to develop cheaper hedges. That is, if other traders are avoiding a stock because they cannot figure out how to hedge their exposure, the ability to hedge would create an edge.....
The Secret to SAC's Returns May Be Weirdness
John Carney | Senior Editor

Why financial markets tend toward efficiency. There's money to be made in locating inefficiencies.

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