Wednesday, November 28, 2012

Academic Papers, Inefficiencies and Alpha.

Here is an interesting article on The Economist a couple of week's ago on academic articles trying to find hidden inefficiencies in stocks markets. The story talks about whether these inefficiencies uncovered by academics have disappeared over time or not.

In Finance, "alpha" is the component of returns that cannot be explained common sources of risk (like the movements of the S&P500) and several academics spend their careers trying to find anomalies that cannot be explained by current models. Thus, chasing positive alpha is what any active manager is trying to get. Of course given the huge number of people (myself included) looking at the same databases, there is always the danger of data-mining, finding patterns that are just flukes (like the Halloween effect, etc.). 

However, there are some anomalies that still persist even after they have been widely published and analyzed. This can either be due to (i) the benchmark models are missing some component of risk, (ii) market frictions (like trading costs or investment constraints) that prevent inefficiencies from being corrected, (iii) behavioral biases that human beings suffer from.

My hunch is, as things often are in life, that the answer lies in a combination them. Anyway, no wonder hedge funds and banks pay top money for good academics to join their ranks.

No comments:

Post a Comment