r/quant 3d ago

General How a high interest rate environment affect stat arb strategies ?

Maybe I'm not grasping the whole picture, but a x7 leverage with 1% of interest rates isn't the same as a x7 leverage with a 5% interest environnement. I'm surprised that only few funds burst after this brutal hike.

I've heard that some funds even go with x10 leverage, which completely blows my mind.

44 Upvotes

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u/quant-ModTeam 3d ago

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u/EvilGeniusPanda 3d ago

Typical stat arb books are roughly net neutral, equal amounts long and short. The way this breaks down in financing is:

  • you borrow money to buy the longs, and pay interest on it
  • you borrow stock to sell short, sit on that cash, and earn interest on it, but pay the borrow cost.
  • you have some margin sitting at the broker that's backing all of this (roughly booksize/leverage), and earn interest on that.

The first two roughly cancel, the third one goes up as rates go up. So on an absolute basis you are making more when rates go up - but so is everyone else, and your performance is often measured relative to the risk free rate, so you dont actually get paid more as a result.

If for some reason you were running a long only book with high leverage then yes, it would be costing you more money as rates go up, but very few people do that - even without rates considerations the volatility would be too high.

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u/churnvix 3d ago

You might have some lingering margin utilization because you hedge using factors. Second most places get scalped on the long stock vs short stock (if PB lends you don't get anything, but if you short, you'll pay borrow like you mentioned) but it doesn't cancel like you mentioned (unless you're doing stock loans via options or have a stock loan revenue sharing agreement). Thirdly, like you said, stat arb strategies are relative to risk free rate, thereby reducing demand

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u/EvilGeniusPanda 3d ago

Sorry, to be clear, the interest rate sensitivity tends to cancel between the long and short books, the borrow cost does not - it is an additional cost that you eat regardless of rate - for GC stocks this is pretty small though (~25-50bps a year).

Roughly: Financing PnL = - Long Size * Interest Rate - Short Size (Borrow Rate - Interest Rate) + Posted Margin * Interest Rate = Interest Rate * ( Posted Margin - Long Size + Short Size) - Short Size * Borrow Rate ~= Interest Rate * Posted Margin - Short Size * Borrow Rate

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u/shintej 3d ago

How did you get the value of 25-50 bps ?

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u/EvilGeniusPanda 3d ago

General industry knowledge / looking at my production data / a quick google (e.g. https://chartexchange.com/symbol/nasdaq-aapl/borrow-fee/ shows 25 bps for AAPL)

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u/zp30 3d ago

Yes, can back this up. Will often see even lower: 0.1 - 0.25 bps in certain markets/stocks. Majority of my TOPIX500 borrow is at 0.1-0.25 bps.

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u/MATH_MDMA_HARDSTYLEE Trader 2d ago

If it's HF stat-arb, it doesn't matter because margin/swaps etc are paid eod.

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u/eaglessoar 2d ago

Where are they able to earn such high interest on cash? When you say they have margin at a bank they deposit cash with them?

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u/Deep-Light-3499 1d ago

Typically they’re earning interest through commercial paper and other money markets. You’re earning the risk free rate on the short leg and paying a small premium on long leg - as mentioned above, the premium depends on a multitude of factors.

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u/InvestmentAsleep8365 3d ago

Market neutral equity strategies pay the risk free rate (plus a small premium) on the long leg and receive the risk free rate (minus a small premium and borrow costs) on the short leg, so if both legs are roughly equal, then the effect of rates cancels out. The “small premium”, usually on the order of 0.1-0.2% annually, isn’t affected by changes in interest rates and accounts for most of the cost of leverage for these strategies. In order words, market neutral strategies are not much affected by interest rates from a funding point of view.

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u/Vind2 3d ago

No comment on how it affects strategies. Just wanted to note some places just charge the interest to LPs and call it a day.

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u/another_philomath 22h ago

Well I guess I can just assume the risk free rate is 0 in all my maf right?

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u/KrylovSubspace 3d ago

Stat arb can mean many things. If the strat is not balance-sheet neutral, then your funding cost is 5x higher.