In response to my EMH interpretation that there is no replicable way to beat the market, Noah says
There are lots of hedge fund guys who do make a lot of money writing computer programs to time the market…
And of course computer programs are replicable — as opposed to well honed intuition, which is not replicable.
As I mentioned I have been backing off that stance.
Still, I think the question is whether or not the quants are just "picking up pennies in front of a steam roller" That is, are they making risk adjusted above average returns or have they just found a way to hide the fact that they are taking on lots of risk?
Perhaps this is something Mike Konczal would like to weigh in on.
Note obviously, taking on lots of leverage and hence risk is a key ingredient in many quant trades, but the question is whether or not you are fundamentally just making money on risk, or do you have a kernel of above average risk adjusted return.
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Thursday ~ September 24th, 2009 at 11:27 pm
Noah
What I was thinking is that there may be ways to reliably beat the market, but they couldn’t really be used by a large percentage of the market, or they’d disturb the system.
For example, imagine if a quant with a bunch of computers traveled back in time to the 50s and started timing the market. He’d probably be able to make some excess returns by doing that, as long as he managed to keep his equipment and technique secret from everyone else, and as long as he didn’t get too big. Super-smart people in the present day might be able to do a more minor version of the same thing, just by having some algorithms that nobody else has happened to discover yet. Of course, the advantage of those particular algorithms probably won’t last long (since the rest of the pack will catch up quick), so the extra-smart folks will have to have to try to find a new market-beating approach, which makes an analysis of the long-term excess returns from their original temporarily-market-beating strategy somewhat difficult…
Sunday ~ September 27th, 2009 at 6:50 pm
ao
I see two possible scenarios to explain hedge fun returns, and the lack of long-run performance correlations, but large short term profits.
1) a small number of firms discovers algorithms that beat the market, but only gain short term advantages because other firms quickly discover those same algorithms.
2) the returns are random, the algorithms are nonsense, and by chance some firms win in the short run, but the randomness is means returns are uncorrelated in the long-run.
#2 is more parsimonious and does not contradict the EMH, and I think more convincing. #1 sounds like your theory Noah, and perhaps yours as well Karl. Is that correct? And if so, why do you prefer that theory over #2?