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Testing Market Efficiency Using Statistical Arbitrage with Applications to Momentum and Value StrategiesRobert A. JarrowCornell University - Samuel Curtis Johnson Graduate School of Management Steve HoganCredit Suisse First Boston Melvyn TeoSingapore Management University - School of Business Mitch WarachkaClaremont Colleges - Robert Day School of Economics and Finance April 15, 2003 Abstract: 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 working papers seriesDate posted: May 25, 2003Suggested CitationContact Information
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