[Note: This post was an April Fool’s joke!]
The volatility we’ve experienced in the last five years has challenged every investor. Yes, diversification can help, but many of the leading minds in finance have been looking for ways to improve on the now discredited Modern Portfolio Theory. I recently met with a quantitative analyst who believes he’s made a breakthrough.
The analyst did not want me to reveal his identity, so I’ll call him Sheldon. His model is based on a concept he calls “quantitative arbitrage,” or QA. The basic idea is combining long and short positions in a portfolio to dampen market volatility. “You remember Newton’s laws of motion from high school physics,” Sheldon says. “The third law says that for every force applied, there is an equal and opposite force. QA is essentially the same idea, but with much more advanced equations.”
At first, I didn’t believe it either. After all, long and short positions should cancel each other out and produce a return of zero. Indeed, after expenses the returns should be negative. But Sheldon has compensated for that by using leverage. “I’ve designed an algorithm that determines the right balance between a leveraged long position and its inverse corollary,” he says.