When Systematic Strategies Decay

47 Pages Posted: 18 May 2021 Last revised: 1 Jul 2021

See all articles by Antoine Falck

Antoine Falck

Capital Fund Management International Inc.

Adam Rej

Capital Fund Management International Inc.

David Thesmar

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: May 14, 2021

Abstract

In this paper, we ask which ex-ante characteristics empirically predict the out-of-sample drop in risk-adjusted performance of published stock anomalies. Our sample is a large cross- section of anomalies published in finance and academic journals, and we define out-of-sample as the post-publication period. Our set of predictors of OOS decay is inspired by two standard hypotheses: arbitrage capital flowing into newly published strategies, and in-sample overfitting linked to multiple hypothesis testing. The year of publication alone – compatible with both hypotheses – explains 30% of the variance of Sharpe decay across predictors: Every year, the Sharpe decay of newly-published factors increases by 5ppt. The other important variables are directly related to overfitting. One of our two “complexity” variables, the number of operations required to calculate the signal, predicts a significant drop of performance. Also, both measures of in-sample “sensitivity to outliers” are shown to matter. Together, these three overfitting- related variables add another 15% of explanatory power. Some arbitrage-related variables are statistically significant, but their predictive power is marginal.

Keywords: factor returns, arbitrage, overfitting

JEL Classification: G14, G15, G40

Suggested Citation

Falck, Antoine and Rej, Adam and Thesmar, David, When Systematic Strategies Decay (May 14, 2021). Available at SSRN: https://ssrn.com/abstract=3845928 or http://dx.doi.org/10.2139/ssrn.3845928

Antoine Falck

Capital Fund Management International Inc. ( email )

The Chrysler Building, 55th floor,
405 Lexington Avenue,
New York, NY 10174
United States

Adam Rej

Capital Fund Management International Inc. ( email )

The Chrysler Building, 55th floor
405 Lexington Avenue
New York, NY 10174
United States
+1 6469578018 (Phone)

David Thesmar (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
Cambridge, MA 02142
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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