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Seeking Thunder

Michael LaCroix, Samson Johnson, bahareh baharinezhad, Joshua Pfeffer, Atharva Patil


We revisit a trading strategy proposed by Lynch et al. (2019) that aims to take advantage of the strong correlations in price action between constituent stocks of Exchange Traded Funds (ETFs). When an ETF experiences a high-volume negative-return day of trading, potentially from some event relevant to a subset of the constituent stocks, the stocks contained in the ETF show higher correlations among themselves than on an average trading day. Some stocks within the ETF may not be fundamentally impacted by the event, and if one suspects these “outsider stocks” to return to their baseline value it provides a profitable opportunity to purchase them at a discount. We implement the strategy proposed by Lynch et al. on more recent data and we recover the same observed increase in correlated price action among ETF constituent stocks. However, we do not recover the same alpha as the authors found in putting their strategy to practice.

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