Chapter 20

An accounting accrual is the recognition of a value based on anticipation of a transaction.

Asynchronous trading is an example of market inefficiency in which news affecting more than one stock may be assimilated into the price of the stocks at different speeds.

The breadth of a strategy is the number of independent active bets placed into an active portfolio.

Earnings momentum is the tendency of earnings changes to be positively correlated.

Earnings surprise is the concept and measure of the unexpectedness of an earnings announcement.

Equity long/short funds tend to have net positive systematic risk exposure from taking a net long position, with the long positions being larger than the short positions.

Equity market-neutral funds attempt to balance short and long positions, ideally matching the beta exposure of the long and short positions and leaving the fund relatively insensitive to changes in the underlying stock market index.

Richard Grinold in 1989 proposed the Fundamental Law of Active Management (FLOAM), which identifies two key components of actively managed investment strategies: breadth and skill.

Illegal insider trading varies by jurisdiction but may involve using material nonpublic information, such as an impending merger, for trading without required disclosure.

The information coefficient (IC) measures managerial skill as the correlation between managerial return predictions and realized returns.

Markets are said to be informationally efficient when security prices reflect available information.

Issuance of new stock is a firm's creation of new shares of common stock in that firm and may occur as a result of a stock-for-stock merger transaction or through a secondary offering.

Trading by insiders can be legal insider trading when it is performed subject to legal restrictions.

The limits to arbitrage refer to the potential inability or unwillingness of speculators, such as equity hedge fund managers, to hold their positions without time constraints or to increase their positions without size constraints.

Liquidity in this context is the extent to which transactions can be executed with minimal disruption to prices.

Investment strategies that can be identified based on available information and that offer higher expected returns after adjustment for risk are known as market anomalies, and they are violations of informational market efficiency.

Market impact is the degree of the short-term effect of trades on the sizes and levels of bid prices and offer prices.

A market maker is a market participant that offers liquidity, typically both on the buy side by placing bid orders and on the sell side by placing offer orders.

Mean neutrality is when a fund is shown to have zero beta exposure or correlation to the underlying market index.

Multiple-factor scoring models combine the factor scores of a number of independent anomaly signals into a single trading signal.

Net stock issuance of new stock minus share repurchases.

Nonactive bets are positions held to reduce tracking error rather than to serve as return-enhancing active bets.

Another potential source of abnormal profits for hedge funds is overreacting in which short-term price changes are too large relative to the value changes that should occur in a market with perfect informational efficiency.

Pairs trading is a strategy of constructing a portfolio with matching stocks in terms of systematic risks but with a long position in the stock perceived to be relatively underpriced and a short position in the stock perceived to be relatively overpriced.

A post-earnings-announcement drift anomaly has been documented, in which investors can profit from positive surprises by buying immediately after the earnings announcement or selling short immediately after a negative earnings surprise.

Price momentum is trending in prices such that an upward price movement indicates a higher expected price and a downward price movement indicates a lower expected price.

Providing liquidity refers to the placement of limit orders or other actions that increase the number of shares available to be bought or sold near the current best bid and offer prices.

When a company chooses to reduce its shares outstanding, a share buyback program is initiated, and the company purchases its own shares from investors in the open market or through a tender offer.

Short interest is the percentage of outstanding shares that are currently held short.

Short-bias funds have larger short positions than long positions, leaving a persistent net short position relative to the market index that allows these funds to profit during times of declining equity prices.

Speculation is defined as bearing abnormal risk in anticipation of abnormally high expected returns.

Standardized unexpected earnings (SUE) is a measure of earnings surprise.

More generally, taking liquidity refers to the execution of market orders by a market participant to meet portfolio preferences that cause a decrease in the supply of limit orders immediately near the current best bid and offer prices.

An empirical test of market efficiency is a test of joint hypotheses, because the test assumes the validity of a model of the risk-return relationship to test whether a given trading strategy earns consistent risk-adjusted profits.

Another potential source of abnormal profits for hedge funds is underreacting in which short-term prices changes are too small relative to the value changes that should occur in a market with perfect informational efficiency.

An uptick rule permits short sellers to enter a short sale only at a price that is equal to or higher than the previous transaction price of the stock.

Variance neutrality is when fund returns are uncorrelated to changes in market risk, including extreme risks in crisis market scenarios.