Abstract
In this paper, we use a statistical arbitrage method in different developed and emerging countries to show that the profitability of the strategy is based on the degree of market efficiency. We will show that our strategy is more profitable in emerging ones and in periods with greater uncertainty. Our method consists of a Pairs Trading strategy based on the concept of mean reversion by selecting pair series that have the lower Hurst exponent. We also show that the pair selection with the lowest Hurst exponent has sense, and the lower the Hurst exponent of the pair series, the better the profitability that is obtained. The sample is composed by the 50 largest capitalized companies of 39 countries, and the performance of the strategy is analyzed during the period from 1 January 2000 to 10 April 2020. For a deeper analysis, this period is divided into three different subperiods and different portfolios are also considered.
Highlights
The Efficient Market Hypothesis (EMH) was introduced by Cootner [1] and Samuelson [2]
We propose to extend the analysis to the 50 largest capitalized companies in 39 so-called advanced and emerging countries to see if a Pairs Trading strategy based on Hurst Exponent, which is a market memory indicator, can obtain a significant profit during different periods
We look at market efficiency by comparing the performance of an arbitrage technique based on the Hurst exponent in emerging and developed markets
Summary
The Efficient Market Hypothesis (EMH) was introduced by Cootner [1] and Samuelson [2]. When markets are fully efficient, neither technical analysis, fundamental analysis nor insider information enable an investor to obtain returns greater than those that could be obtained by holding random portfolios or individual stocks with the same risk. Many financial economists and investors accept that the presence of the first two scenarios are almost impossible even in high capitalized markets (Campbell et al [4] and Grossman and Stiglitz [5]); this is why the weak-form version of market efficiency is the most tested criterion in the financial literature. To test the level of market efficiency has been a quite popular topic in financial literature because, if a market is not efficient, this means that future stock prices are somewhat predictable based on past stock price which enable investors to earn excess risk adjusted rates of return. Some researchers have tested whether technical analysis is able to provide abnormal returns to the investors (see, for example, Fama and Blume [7], Fama and French [8], Olson [9], Rosillo et al [10], Shynkevich [11], Metghalchi et al [12] or Bobo and Dinica [13])
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