Quantitative Stock Selection: Transfer Coefficients Campbell R. Harvey Duke University National Bureau of Economic Research

Transfer Coefficients 1.Certain factors induce excessive turnover. 2.Example is a reversal factor, such as a lagged return. 3.Selection routine needs to balance the information in the signal with the cost of implementing

Transfer Coefficients 4. One approach is to limit turnover. For example, a factor might induce 120% annual turnover. One might impose a constraint to limit the turnover to approximate 60% per year. 5. To implement in terms of scoring screens, suppose in any month about 10% of the stocks leave or are added (120% per year). (a) Calculate the difference between the old scores and the new scores. Consider the highest 25 th percentile moves and the lowest 25 th percentile moves. Ignore the middle.

Transfer Coefficients 5. (b) Consider the old ranking and the new ranking. Only consider the stocks that move up and down a lot. For example, if you have quintiles with 100 stocks in each, and stock XYZ drops from rank 100 (Q1) to 101 (Q2) you do not sell (assuming you are long Q1 and short Q5)

Transfer Coefficients 6. Alternatively, one can smooth the signal. For example, instead of looking at RR you look at a three month moving average of RR. The smoother factor will induce less rebalancing. 7. Both of these techniques degrade the signal from the factor. The transfer coefficient is the correlation between your signal changes and your weight changes.