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Does trading strategy based on overreaction and stock-bond decoupling generate additional profits?
Bosák, Martin ; Čech, František (advisor) ; Baruník, Jozef (referee)
Studying whether new trading rules provide higher returns than the buy-and-hold strategy is relevant for both finance theory and the asset management field. In this thesis, we examine the profitability of the newly proposed trading strategy based on the concept of price overreaction on eight developed stock indices. In comparison to other studies, we extend a definition of price overreaction with an inclusion of a minimum volatility threshold. Based on the Ordinary Least Squares model, we find that a volatility condition significantly improves the predictability of return reversals after positive price overreaction. For comparison with the buy-and-hold, we use Hansen's Superior Predictive Ability test that corrects the data snooping bias. Despite better annualised returns during in-sample and out-of-sample periods, the results show that the proposed strategy is not superior to the buy-and-hold at any stock index due to heavy reliance on the predictions of the largest declines. Nevertheless, we confirm the effect of decoupling (flight to quality) that can positively affect our strategy, but only when we do not take into account transaction costs. In the end, we summarize behavioural concepts that lie behind our strategy as the overreaction and decoupling are mostly justified with cognitive biases.
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Data-Snooping Biases in Backtesting
Krpálek, Jan ; Bašta, Milan (advisor) ; Malá, Ivana (referee)
In this paper, we utilize White's Reality Check, White (2000), and Hansen's SPA test, Hansen (2004), to evaluate technical trading rules while quantifying the data-snooping bias. Secondly, we discuss the result with Probability of Backtest Overfitting framework, introduced by Bailey et al. (2015). Hence, the study presents a comprehensive test of momentum trading across the US futures markets from 2004 to 2016. The evidence indicates that technical trading rules have not been pro?table in the US futures markets after correcting for the data snooping bias.
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