Working Paper: NBER ID: w17150
Authors: Scar Jorda; Alan M. Taylor
Abstract: This paper introduces new nonparametric statistical methods to evaluate zero-cost investment strategies. We focus on directional trading strategies, risk-adjusted returns, and the investor's decisions under uncertainty as the core of our analysis. By relying on classification tools with a long tradition in the sciences and biostatistics, we can provide a tighter connection between model-based risk characteristics and the no-arbitrage conditions for market efficiency. Moreover, we extend the methods to multicategorical settings, such as when the investor can sometimes take a neutral position. A variety of inferential procedures are provided, many of which are illustrated with applications to excess equity returns and to currency carry trades.
Keywords: Zero-cost investment strategies; Nonparametric methods; Directional trading; Risk-adjusted returns; Market efficiency
JEL Codes: C14; C59; G14; G17
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nonparametric methods (C14) | risk-adjusted returns (G12) |
| absence of arbitrage conditions (G19) | risk-adjusted returns (G12) |
| investors' decision-making under uncertainty (G11) | performance of trading strategies (G17) |
| direction of trades (F10) | profitable outcomes (L21) |
| statistical models used (C52) | conclusions about effectiveness of investment strategies (G11) |
| varying loss functions (C51) | assessments of model utility (C52) |
| certain signals (C24) | profitable trades (G13) |
| use of nonparametric evaluation techniques (C52) | improved investment outcomes (G11) |