Testing Market Efficiency using Statistical Arbitrage with Applications to Momentum and Value Strategies
This paper introduces the concept of statistical arbitrage, a long horizon trading opportunity that generates a riskless profit and is designed to exploit persistent anomalies. Statistical arbitrage circumvents the joint hypothesis dilemma of traditional market efficiency tests because its definition is independent of any equilibrium model and its existence is incompatible with market efficiency. We provide a methodology to test for statistical arbitrage and then empirically investigate whether momentum and value trading strategies constitute statistical arbitrage opportunities. Despite adjusting for transaction costs, the influence of small stocks, margin requirements, liquidity buffers for the marking-to-market of short-sales, and higher borrowing rates, we find evidence that these strategies generate statistical arbitrage.
Hogan, S., Jarrow, R., Teo, M., & Warachka, C. (2004). Testing market efficiency using statistical arbitrage with applications to momentum and value strategies. Journal of Financial Economics, 73(3), 525-565. https://doi.org/10.1016/j.jfineco.2003.10.004
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NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Financial Economics. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Financial Economics, volume 73, issue 3, in 2004. https://doi.org/10.1016/j.jfineco.2003.10.004
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