[Some] Hedge Funds have been having a harder time, since about 2008 until today, with the last year being particularly difficult. I have been studying traditional highly cointetrated pairs (just the simplest case of two series), and watching their cointegration disintegrate in the past few years. So pairs like WMT TGT are no longer cointegrated at any lag, nor are pairs like KO and PEP. So my hypotheses is, I contend that the game has gotten much harder, and this is one of the reasons some traditional hedge funds are disappearing. One thing that begs the question then is, did the dog wag the tail, or the other way around? In other words, did stocks trade in sync more often in the past because their value was similar and their earnings generation was pretty similar, or did they just trade that way because the players themselves caused this illusion by keeping the stocks trading in a range in relation to each other? If it is the former, what economic random variable accounts for the break from cotrending? Can the current economic recession have that much effect on businesses that are in an almost identical in the way they generate revenue?
nitro, Could you discuss the disappearence of the retail trader in the market and how this might affect or has nothing to do with your points in the opening post? I may understand incorrectly, but hasn't the retail traders exit from the market leave less money on the table for the pro's to take? ES
I don't think this is the problem. The leaving of the retail trader hurt the arbitrageur, not the pair trader, imo.
If you look at the post/video at the bottom of this page, you begin to understand that the search has become far more dimensional than it used to be http://www.elitetrader.com/vb/showthread.php?s=&threadid=233300&perpage=6&pagenumber=4 So, now instead of looking for cointegrated pairs, we have to look for more symbols to add to the mix. What is strange is, you would think the reason is that the [simple] pairs have been arbed away. But in fact, they are diverging more than ever. I don't understand it. Perhaps corporations are hiring managers that add value above and beyond the obvious way to generate revenue and steal market share, so that there is truly a difference in the performance of e.g., KO and PEP?
The first thing that comes to my mind is to explore option trades. I wonder if option activity could be a contributing factor rather than fundamental.
That is an interesting idea, but at first glance that argument shouldn't hold water. I have to think it through.
I am beginning to suspect that the reason is a shift from local economies to international economies. Does this mean that we have to take currency exchange rates into consideration, and therefore how good the company is at hedging [its] currency risk? This is wild, but probably close to the truth. Note that it all boils down to higher dimensional correlates, and their decay. One idea is to take a companies whose business is strictly local, and see if there is a longer term cointegration in these companies into the present time.
How about this idea: as consumer and business spending took a nose dive in the last 4 years, industries that used to support oligopolies now don't have enough sales to support multiple competitors. So the top pack is thinning out resulting in only one or two clear leaders per industry, i.e., when the money gets tight, the winner takes all. So previously correlated competitors are now de-correlated as the second tier companies can no longer compete, while the top tier continues to do well. Just my novice opinion.
I'm a little confused how anyone can know for certain that there is a decrease in retail traders in the volume... also confused how people know that more of the volume now is IRA, etc. and not institutional money (besides talking to friends at different firms during lunch).