quantifying friction
I recently had a pretty visceral encounter with the forces of friction. No, I didn’t fall off my bike - I’m talking about the friction inherent in trading activities. I’ve mentioned Andrew Lo’s market-neutral long-short algorithm before and it sees service as my blogging muse once again. I’ve modified his original algorithm such that it behaves reasonably well though, as he observes, it’s a strategy in long term decline. My recollection was that one might expect 15-20% from an unlevered deployment of the strategy.
Recently, I went to play with it and to my shock and horror it had become a wretched loser. In fact, an incredible loser. What had happened? I looked throughout my code and couldn’t find changes; this was corroborated by my CVS repository - no changes had been made to the strategy in a long while. Any coder is familiar with the natural entropy of software systems known pejoratively as “code rot” but this seemed an especially extreme case.
back-testing, hedge funds, performance analysis, strategy development
