Economy – Quantitative Finance – Statistical Finance
Scientific paper
2007-09-25
Expert Systems with Applications (2009), 36, 2819-2830.
Economy
Quantitative Finance
Statistical Finance
28 pages, 6 figures, submitted to journal
Scientific paper
10.1016/j.eswa.2008.01.062
A number of recent emerging applications call for studying data streams, potentially infinite flows of information updated in real-time. When multiple co-evolving data streams are observed, an important task is to determine how these streams depend on each other, accounting for dynamic dependence patterns without imposing any restrictive probabilistic law governing this dependence. In this paper we argue that flexible least squares (FLS), a penalized version of ordinary least squares that accommodates for time-varying regression coefficients, can be deployed successfully in this context. Our motivating application is statistical arbitrage, an investment strategy that exploits patterns detected in financial data streams. We demonstrate that FLS is algebraically equivalent to the well-known Kalman filter equations, and take advantage of this equivalence to gain a better understanding of FLS and suggest a more efficient algorithm. Promising experimental results obtained from a FLS-based algorithmic trading system for the S&P 500 Futures Index are reported.
Montana Giovanni
Triantafyllopoulos Kostas
Tsagaris Theodoros
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