The alpha life cycle of quantitative strategy

Yi Zhou, Jianwu Lin

Abstract: Recent research and trading activity indicate that after the publication of some strategies and crowded trading, the strategies' performance will keep declining, which is called alpha decay. This paper tries to model the process by behavioral finance theory and active portfolio management theory. We will introduce gambler's ruin problem and use a simple model to rebuild the market structure, divide the market participants into two part: the rational investors and the noise traders. The model will explain the source of alpha and the proportion changes of the two kinds of investor will influence the profitability of alphas, which displays Alpha Life Cycle. Through periodic analysis of the phenomenon of alpha, investors can identify their investment strategies' the position in the life cycle, which will help portfolio management with multiple quantitative strategies, select strategies which in early positions of life cycles, so that their portfolios can maintain long-term excess returns.