Behavioral Arbitrage - Design Strategies That Time Market Mistakes¶
By Cheng Peng
Behavioral Arbitrage refers to arbitrage opportunities that are based on how human biases affect the capital markets, especailly prices - these opportunities are typically known as the Behavioral Gap. There are multiple ways human behavior can influence market prices, and so, awareness of these behaviors can help in our analysis and trading. Generally, there are two types of biases: cognitive and emotional. Cognitive biases are generally hard to notice because they appear when interpreting and processing information. Emotional biases are easier to recognize - but difficult to manage since our biological responses can upset even the most rational plans.
Proposed Hypothesis Framework¶
- What is the market thinking?
- What is the current sentiment of the market towards this asset? Is it bullish, bearish or going unnoticed?
- Why is the market wrong?
- Based on current information, is the market sentiment correct? Too extreme or just wrong?
- How wrong is the market?
- What conditions can further explain the difference between sentiment and reality?
Event Studies¶
This framework is generally enough to be applied to any model - however, I find event studies to be particularly fitting for behavioral explanations. Event studies bring homogeneity to the data by filtering and isolating most of the noisy information irrelevant to our samples. This notebook will focus on Earnings Announcements in stocks, and especially how new information directly impacts future market prices.
First, we create a few convenient methods for running event studies with a factor.
import alphalens
from scipy import stats
from quantopian.pipeline import Pipeline
from quantopian.research import run_pipeline
from quantopian.pipeline.data.builtin import USEquityPricing
from quantopian.pipeline.factors import Returns
from quantopian.pipeline.experimental import QTradableStocksUS
from quantopian.pipeline.data import Fundamentals
from quantopian.pipeline.factors.eventvestor import BusinessDaysUntilNextEarnings, BusinessDaysSincePreviousEarnings
# Earnings Imports Zacks
from quantopian.pipeline.data.zacks import EarningsSurprises
from quantopian.pipeline.factors.zacks import BusinessDaysSinceEarningsSurprisesAnnouncement
from quantopian.pipeline.factors.eventvestor import BusinessDaysUntilNextEarnings, BusinessDaysSincePreviousEarnings
start = '%s-01-01' % 2011
end = '%s-12-31' % 2015
def make_pipeline(factor, universe):
combined_alpha = factor.zscore(mask=universe)
pipe = Pipeline(
columns={
'combined_alpha': combined_alpha
},
screen=universe & combined_alpha.notnan()
)
return pipe
def run_new_event_study(
universe=QTradableStocksUS(),
factor=Returns(window_length=5),
days_before=5, days_after=5,
long_short=False,
quantiles=None,
bins=[0],
periods=(1,2,3,4,5),
price_type='open_price'):
results = run_pipeline(make_pipeline(factor, universe), start_date=start, end_date=end)
security_universe = results.index.levels[1].unique().tolist()
prices = get_pricing(security_universe, start_date=start, end_date=end, fields=price_type)
factor_data = alphalens.utils.get_clean_factor_and_forward_returns(
factor=results['combined_alpha'],
prices=prices,
periods=periods,
quantiles=quantiles,
bins=bins
)
alphalens.tears.create_event_study_tear_sheet(
factor_data,
prices,
avgretplot=(days_before, days_after),
)
Recency Biases Pre Earnings¶
- What is the market thinking?
- Weekly returns + last earnings surprise
- Why is the market wrong?
- Exaggeration based on last earnings surprise
- How wrong is the market?
- Unstable earnings estimates lead to larger discrepancies
Event Studies To Run¶
- Earnings Surprise Before Earnings
- Weekly Returns Before Earnings
- (Earnings Surprise + Weekly Returns) Before Earnings
- (Earnings Surprise + Weekly Returns) Before Earnings Filtering For Unstable Estimates
Earnings Surprise Before Earnings¶
factor = EarningsSurprises.eps_pct_diff_surp.latest
point_in_time = BusinessDaysUntilNextEarnings().eq(1)
universe = QTradableStocksUS() & factor.notnan() & point_in_time
run_new_event_study(
universe=universe,
factor=factor,
days_before=0, days_after=5,
long_short=True,
bins=None, quantiles=4)
Weekly Returns Before Earnings¶
factor = Returns(window_length=5)
point_in_time = BusinessDaysUntilNextEarnings().eq(1)
universe = QTradableStocksUS() & factor.notnan() & point_in_time
run_new_event_study(
universe=universe,
factor=factor,
days_before=0, days_after=5,
long_short=True,
bins=None, quantiles=4)
(Earnings Surprise + Weekly Returns) Before Earnings¶
factor = (EarningsSurprises.eps_pct_diff_surp.latest.rank() + Returns(window_length=5).rank())
point_in_time = BusinessDaysUntilNextEarnings().eq(1)
universe = QTradableStocksUS() & factor.notnan() & point_in_time
run_new_event_study(
universe=universe,
factor=factor,
days_before=0, days_after=5,
long_short=True,
bins=None, quantiles=4)
(Earnings Surprise + Weekly Returns) Before Earnings With Unstable Estimates¶
factor = (EarningsSurprises.eps_pct_diff_surp.latest.rank() + Returns(window_length=5).rank())
filter_factor = EarningsSurprises.eps_std_dev_est.latest
point_in_time = BusinessDaysUntilNextEarnings().eq(1)
universe = QTradableStocksUS() & factor.notnan() & filter_factor.notnan()
universe = filter_factor.rank(mask=universe).percentile_between(70, 100) & point_in_time
run_new_event_study(
universe=universe,
factor=factor,
days_before=0, days_after=5,
long_short=True,
bins=None, quantiles=4)
Price Inefficiency Post Earnings¶
- What is the market thinking?
- Adjusting prices from new earnings announcement
- Why is the market wrong?
- Information overload from multiple earnings
- How wrong is the market?
- Consistent earnings surprises go unnoticed because of limited attention
Event Studies To Run¶
- PE Ratio Post Earnings
- PE Ratio Post Earnings Filtering For Low Absolute Earnings Surprise
PE Ratio Post Earnings¶
factor = Fundamentals.pe_ratio.latest
point_in_time = BusinessDaysSincePreviousEarnings().eq(1)
universe = QTradableStocksUS() & factor.notnan() & point_in_time
run_new_event_study(
universe=universe,
factor=factor,
days_before=0, days_after=5,
long_short=True,
bins=None, quantiles=4)
PE Ratio Post Earnings With Low Absolute Earnings Surprise¶
factor = Fundamentals.pe_ratio.latest
filter_factor = (EarningsSurprises.eps_pct_diff_surp.latest**2)**0.5
point_in_time = BusinessDaysSincePreviousEarnings().eq(1)
universe = QTradableStocksUS() & factor.notnan() & filter_factor.notnan()
universe = filter_factor.rank(mask=universe).percentile_between(0, 30) & point_in_time
run_new_event_study(
universe=universe,
factor=factor,
days_before=0, days_after=5,
long_short=True,
bins=None, quantiles=4)
This notebook is for informational purposes only and does not constitute as investment advice in any security or any form. There are no guarantees for accuracy or completeness, and all information is subject to the reader's interpretation.