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Testing Market Efficiency Using Statistical Arbitrage with Applications to Momentum and Value Strategies

48 Pages Posted: 25 May 2003  

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Steve Hogan

Credit Suisse First Boston

Melvyn Teo

Singapore Management University - Lee Kong Chian School of Business

Mitch Warachka

University of San Diego

Date Written: 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.

Keywords: market efficiency, statistical arbitrage, arbitrage, momentum, value

JEL Classification: G12, G14

Suggested Citation

Jarrow, Robert A. and Hogan, Steve and Teo, Melvyn and Warachka, Mitch, Testing Market Efficiency Using Statistical Arbitrage with Applications to Momentum and Value Strategies (April 15, 2003). Available at SSRN: https://ssrn.com/abstract=386440 or http://dx.doi.org/10.2139/ssrn.386440

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Steve Hogan

Credit Suisse First Boston ( email )

11 Madison Avenue
New York, NY 10010
United States

Melvyn Teo (Contact Author)

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore, 178899
Singapore
+65 6828 0735 (Phone)
+65 6822 0777 (Fax)

Mitch Warachka

University of San Diego ( email )

5998 Alcala Park
University of San Diego
San Diego, CA 92110-2492
United States

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