4 – M4 L3a 04 Researching Alphas From Academic Papers V4

You may be wondering how to come up with alpha factors and trading strategies. Some sources of inspiration, maybe reading financial news, observing the markets for curious behavior, studying the methods of famous investors both discretionary and want or talking to industry practitioners. We’ll explore academic research papers as a source for alpha factor ideas through the remainder of this lesson and in the next lesson. It’s important to understand a key point before we do this. We should not expect to get strong production-ready alphas ”as is” from academic papers. Why not? Because the very act of publication which makes the paper publicly available also diffuses this information into the market. As participants adopt the trading strategy, the strength of the effect is diffused. Why then do we look at academic papers at all? For four reasons. First, these papers can spur idea generation for us to create derivative works. Second, the work conserve as baseline factors to compare with our own alpha generation. Third, we can learn how professional full-time researchers approach problems and validate their findings. Fourth, perhaps we can learn about new sources of data or novel ways to work with data. Academic research can be published in general interests economic journals, investment focused journals, or open source journals. General interest journals and investment focused journals both require peer review and require a paid subscription. Open source repositories usually include working papers that have not yet been peer reviewed and are also free. Open source repositories for research papers include, SSRN and the archive. One benefit to using open source journals is that there’s a broader selection of papers and their ideas more recent, since peer review is a process that takes time. It helps to figure out which other papers cite a particular article, to see how other researchers attempted to replicate critique or improve upon the original idea. Once you’ve found some papers of interests, scan the abstract and find out if the data use is accessible to you. Focus on papers for which the data is accessible so that you may try to replicate their work. Check that the methodology could potentially be practical. Academic papers almost never include real-world constraints like transaction costs or liquidity directly. You need to make a judgment quickly if you think adding these constraints will completely invalidate the ideas presented. Some papers include these aspects in a roundabout way. They conducted Turnover Analysis or they choose a stock universe that includes more illiquid stocks. Some examples of impractical methods may include choosing a large universe of say 8,000 stocks, in which most of the factor returns are derived from a subset of the small and micro cap stocks. Remember that small and micro cap stocks are less liquid and factors that rely on illiquid stocks may be difficult to implement in practice. Note that the process of finding academic papers, studying papers, implementing the papers and then evaluating them is a very important skill to have as a quantitative researcher. We hope to walk you through some of these examples, so that you will eventually have the confidence to conduct your own research after this course.

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