Michael Isichenko - Quantitative Portfolio Management: The Art and Science of Statistical Arbitrage

Michael Isichenko

Copyright 2021 by Michael Isichenko. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data

Names: Isichenko, Michael, author.

Title: Quantitative portfolio management : the art and science of statistical arbitrage / Michael Isichenko.

Description: Hoboken, New Jersey : John Wiley & Sons, Inc., [2021] | Includes bibliographical references and index.

Identifiers: LCCN 2021013923 (print) | LCCN 2021013924 (ebook) | ISBN 9781119821328 (cloth) | ISBN 9781119821229 (adobe pdf) | ISBN 9781119821212 (epub)

Subjects: LCSH: Portfolio managementMathematical models. | Arbitrage.

Classification: LCC HG4529.5 .I83 2021 (print) | LCC HG4529.5 (ebook) | DDC 332.6dc23

LC record available at https://lccn.loc.gov/2021013923

LC ebook record available at https://lccn.loc.gov/2021013924

Cover Design: Wiley

Cover Image: Michael Isichenko

This book describes the process used by quantitative traders, or quants, a community the author has belonged to for a number of years. Quants are not usually trained as quants, but often come from one of the hard sciences such as mathematics, statistics, physics, electrical engineering, economics, or computer science. The author, a physicist by training, feels guilty for (ab)using the word describing a fundamental concept of quantum physics in the context of quantitative trading, but this slang is too rooted in the industry to be avoided. Having quantitative finance professionals in mind, the intended audience is presumed interdisciplinary, fluent in mathematical notation, not foreign to algorithmic thinking, familiar with basic financial concepts such as market-neutral strategies, and not needing a definition of pnl. This book could be also interesting to those readers who are thinking of joining the quant workforce and wondering if it is worth it.

The quant trading business, especially its alpha part, tends to be fairly secretive, but the traffic of portfolio managers and analysts between quant shops has created a body of common knowledge, some of which has been published in the literature. The book is an attempt to cover parts of this knowledge, as well as to add a few ideas developed by the author in his own free time. I appreciate the concern of some of the more advanced colleagues of mine about letting the tricks of the trade out in the wild. Those tricks, such as machine learning and optimization algorithms, are mostly in the public domain already but are spread over multiple fields. In addition to academic research, Wall Street can learn a lot from Silicon Valley, whose inhabitants have generated a tremendous and less secretive body of knowledge. Using an analogy with cryptography, and learn better coding.

The choice of topics for this book is aligned with the author's personal interests in the field, although an honest attempt is made to cover, in depth or in passing, all relevant parts of statistical arbitrage, a quantitative approach to equity trading. Whether or not a particular formula or approach is expected to help make money (or avoid losses) is not disclosed or opined upon, in part because any application success is data- and implementation-dependent, and in part to keep the reader in suspense. The book is also an attempt to strike a balance between what the author could say and is comfortable saying. In the field of quantitative trading, the more interesting stuff doesn't usually get published. In this book, the reader will hopefully find a few things that might be interesting or at least entertaining.

Any resemblance of described quantitative practices to past or existing firms is coincidental and may not be statistically significant. As Kurt Vonnegut admitted in Slaughterhouse-Five, All this happened, more or less. This book is for quants and, occasionally, about quants.

A lot of the quantitative portfolio management process involves data and code. The exposition style adopted in this book does not include too many charts, tables, or code snippets, although there are some. Instead, the focus is on ideas, motivation for various approaches, and mathematical description seeking a terse and elegant exposition whenever possible. Mathematical formulas tend to be more compact and expressive than code written in any programming language. In addition, and quoting the enormous usefulness of mathematics in the natural sciences is something bordering on the mysterious and ... there is no rational explanation for it.

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1. Accordingly, and for the reader's convenience, the electronic version of this book has multiple hyperlinks to Wikipedia and other URLs.

This book is an unlikely result of some 20 years of trial-and-error discovery. It is also a work in progress. The author will appreciate indication of any omission or error, as well as any feedback from the reader, whose comments are most welcome at .

M.I.

New York-Montauk, June 2020May 2021.

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1. , Communications in Pure and Applied Mathematics, 13(I), February 1960.