Testing Market Efficiency Using Statistical Arbitrage with Applications to Momentum and Value Strategies
Robert A. Jarrow
Cornell University - Samuel Curtis Johnson Graduate School of Management
Credit Suisse First Boston
Singapore Management University - Lee Kong Chian School of Business
Claremont Colleges - Robert Day School of Economics and Finance
April 15, 2003
This paper introduces the concept of statistical arbitrage, a long horizon trading opportunity that generates a riskless profit and is designed to exploit persistent anomalies. Statistical arbitrage circumvents the "joint hypothesis" dilemma of traditional market efficiency tests because its definition is independent of any equilibrium model and its existence is incompatible with market efficiency. We provide a methodology to test for statistical arbitrage and then empirically investigate whether momentum and value trading strategies constitute statistical arbitrage opportunities. Despite controlling for transaction costs and the influence of small stocks, we find evidence that these strategies generate statistical arbitrage. Furthermore, their profitability does not appear to decline over time.
Number of Pages in PDF File: 48
Keywords: market efficiency, statistical arbitrage, arbitrage, momentum, value
JEL Classification: G12, G14
Date posted: May 25, 2003
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