Why and How Systematic Strategies Decay

45 Pages Posted: 18 May 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 propose ex-ante characteristics that predict the drop in risk-adjusted performance out-of-sample for a large set of stock anomalies published in finance and accounting academic journals. Our set of predictors is generated by hypotheses of OOS decay put forward by McLean and Pontiff (2016): 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 factors: Every year, the Sharpe decay of newly-published factors increases by 5ppt. The other important variables are directly related to overfitting: the number of operations required to calculate the signal and two measures of sensitivity of in-sample Sharpe to outliers together 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, Why and How 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

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
334
Abstract Views
1,131
rank
110,366
PlumX Metrics