By Peng Yan
Traditionally, an alpha is defined as the active return from an investment after risk adjustment is applied. In this chapter, alpha means a quantitative model to predict future investment returns.
The start of an alpha design can be a hypothesis, a paper, a story, an inspiration, or just a random idea.
Similar to academic research, many assumptions are wrong, many trials futile. Only a few of them will be successful. We are human, and market participants are human as well. Humans are different as they have different ideas; only a small portion of those ideas may generate profits consistently in the real environment. At times you will have a strong belief that the model will work, yet after testing, it is proven not true or vice versa.
Asset class prices can be affected by many factors, either directly or indirectly. One idea may affect just one and neglect others.
We call the process of testing idea simulation. There are different simulation methods, such as:
In our working environment, simulation means backtest. That is, when there ...