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Article

Dispersion Trading Based on the Explanatory Power of S&P 500 Stock Returns

Department of Statistics and Econometrics, University of Erlangen-Nürnberg, Lange Gasse 20, 90403 Nürnberg, Germany
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Mathematics 2020, 8(9), 1627; https://doi.org/10.3390/math8091627
Received: 16 August 2020 / Revised: 12 September 2020 / Accepted: 17 September 2020 / Published: 20 September 2020
(This article belongs to the Special Issue Quantitative Methods for Economics and Finance)
This paper develops a dispersion trading strategy based on a statistical index subsetting procedure and applies it to the S&P 500 constituents from January 2000 to December 2017. In particular, our selection process determines appropriate subset weights by exploiting a principal component analysis to specify the individual index explanatory power of each stock. In the following out-of-sample trading period, we trade the most suitable stocks using a hedged and unhedged approach. Within the large-scale back-testing study, the trading frameworks achieve statistically and economically significant returns of 14.52 and 26.51 percent p.a. after transaction costs, as well as a Sharpe ratio of 0.40 and 0.34, respectively. Furthermore, the trading performance is robust across varying market conditions. By benchmarking our strategies against a naive subsetting scheme and a buy-and-hold approach, we find that our statistical trading systems possess superior risk-return characteristics. Finally, a deep dive analysis shows synchronous developments between the chosen number of principal components and the S&P 500 index. View Full-Text
Keywords: dispersion trading; option arbitrage; volatility trading; correlation risk premium; econometrics; computational finance dispersion trading; option arbitrage; volatility trading; correlation risk premium; econometrics; computational finance
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MDPI and ACS Style

Schneider, L.; Stübinger, J. Dispersion Trading Based on the Explanatory Power of S&P 500 Stock Returns. Mathematics 2020, 8, 1627. https://doi.org/10.3390/math8091627

AMA Style

Schneider L, Stübinger J. Dispersion Trading Based on the Explanatory Power of S&P 500 Stock Returns. Mathematics. 2020; 8(9):1627. https://doi.org/10.3390/math8091627

Chicago/Turabian Style

Schneider, Lucas, and Johannes Stübinger. 2020. "Dispersion Trading Based on the Explanatory Power of S&P 500 Stock Returns" Mathematics 8, no. 9: 1627. https://doi.org/10.3390/math8091627

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