When are Contrarian Profits Due to Stock Market Overreaction?

The profitability of contrarian investment strategies need not be the result of stock market overreaction. Even if returns on individual securities are temporally independent, portfolio strategies that attempt to exploit return reversals may still earn positive expected profits. This is due to the effects of cross-autocovariances from which contrarian strategies inadvertently benefit. We provide an informal taxonomy of return-generating processes that yield positive [and negative] expected profits under a particular contrarian portfolio strategy, and use this taxonomy to reconcile the empirical findings of weak negative autocorrelation for returns on individual stocks with the strong positive autocorrelation of portfolio returns. We present empirical evidence against overreaction as the primary source of contrarian profits, and show the presence of important lead-lag relations across securities.

Data-Snooping Biases in Tests of Financial Asset Pricing Models

We investigate the extent to which tests of financial asset pricing models may be biased by using properties of the data to construct the test statistics. Specifically, we focus on tests using returns to portfolios of common stock where portfolios are constructed by sorting on some empirically motivated characteristic of the securities such as market value of equity. We present both analytical calculations and Monte Carlo simulations that show the effects of this type of data-snooping to be substantial. Even when the sorting characteristic is only marginally correlated with individual security statistics, 5 percent tests based on sorted portfolio returns may reject with probability one under the null hypothesis. This bias is shown to worsen as the number of securities increases given a fixed number of portfolios, and as the number of portfolios decreases given a fixed number of securities. We provide an empirical example that illustrates the practical relevance of these biases.

Stock Market Prices Do Not Follow Random Walks: Evidence From a Simple Specification Test

In this paper, we test the random walk hypothesis for weekly stock market returns by comparing variance estimators derived from data sampled at different frequencies. The random walk model is strongly rejected for the entire sample period (1962-1985) and for all sub-periods for a variety of aggregate returns indexes and size-sorted portfolios. Although the rejections are largely due to the behavior of small stocks, they cannot be ascribed to either the effects of infrequent trading or time-varying volatilities. Moreover, the rejection of the random walk cannot be interpreted as supporting a mean-reverting stationary model of asset prices, but is more consistent with a specific nonstationary alternative hypothesis.

Two-way quantum communication channels

We consider communication between two parties using a bipartite quantum operation, which constitutes the most general quantum mechanical model of two-party communication. We primarily focus on the simultaneous forward and backward communication of classical messages. For the case in which the two parties share unlimited prior entanglement, we give inner and outer bounds on the achievable rate region that generalize classical results due to Shannon. In particular, using a protocol of Bennett, Harrow, Leung, and Smolin, we give a one-shot expression in terms of the Holevo information for the entanglement-assisted one-way capacity of a two-way quantum channel. As applications, we rederive two known additivity results for one-way channel capacities: the entanglement-assisted capacity of a general one-way channel, and the unassisted capacity of an entanglement-breaking one-way channel.Comment: 21 pages, 3 figure

Adaptive Markets and the New World Order

In the adaptive markets hypothesis (AMH) intelligent but fallible investors learn from and adapt to changing economic environments. This implies that markets are not always efficient but are usually competitive and adaptive, varying in their degree of efficiency as the environment and investor population change over time. The AMH has several implications, including the possibility of negative risk premiums, alpha converging to beta, and the importance of macro factors and risk budgeting in asset allocation policies

Opinion: A new approach to financial regulation

It has been five years since the US Congress enacted the landmark Dodd–Frank Wall Street Reform and Consumer Protection Act; and despite the fact that about 20% of the Act has yet to be implemented (1), several legislative initiatives are now attempting to soften or roll back key provisions. This pattern of regulatory action and reaction is not new. The financial excesses of one period often lead to asset bubbles that burst, ushering in a new period of much greater regulation. This, in turn, is systematically weakened over time as markets recover and we forget the reasons why we imposed such stringent regulations in the first place. Even before Dodd–Frank, the financial industry was among the most highly regulated of industries in the world. However, the many layers of regulation and multiple regulatory agencies were insufficient to prevent financial crisis. Why

Similarity transformations approach for a generalized Fokker-Planck equation

By using similarity transformations approach, the exact propagator for a generalized one-dimensional Fokker-Planck equation, with linear drift force and space-time dependent diffusion coefficient, is obtained. The method is simple and enables us to recover and generalize special cases studied through the Lie algebraic approach and the Green function technique.Comment: 8 pages, no figure

A quantum protocol for cheat-sensitive weak coin flipping

We present a quantum protocol for the task of weak coin flipping. We find that, for one choice of parameters in the protocol, the maximum probability of a dishonest party winning the coin flip if the other party is honest is 1/sqrt(2). We also show that if parties restrict themselves to strategies wherein they cannot be caught cheating, their maximum probability of winning can be even smaller. As such, the protocol offers additional security in the form of cheat sensitivity.Comment: 4 pages RevTex. Differs from the journal version only in that the sentences: "The ordering of the authors on this paper was chosen by a coin flip implemented by a trusted third party. TR lost." have not been remove

On bit-commitment based quantum coin flipping

In this paper, we focus on a special framework for quantum coin flipping protocols,_bit-commitment based protocols_, within which almost all known protocols fit. We show a lower bound of 1/16 for the bias in any such protocol. We also analyse a sequence of multi-round protocol that tries to overcome the drawbacks of the previously proposed protocols, in order to lower the bias. We show an intricate cheating strategy for this sequence, which leads to a bias of 1/4. This indicates that a bias of 1/4 might be optimal in such protocols, and also demonstrates that a cleverer proof technique may be required to show this optimality.Comment: The lower bound shown in this paper is superceded by a result of Kitaev (personal communication, 2001