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[2] Diversified Statistical Arbitrage: Dynamically Combining Mean Reversion and Momentum Investment Strategies

by James Velissaris, Senior Associate, Arden Asset Management, New York City

Christian scholars may wonder why this study is presented to this journal.  Indeed, it does not fall neatly into a faith and learning format.  A strong case, however, is to be made for economic stewardship.  Scripture consistently encourages believers to be good stewards of every resource given to them, pastors preach monetary stewardship–sometimes to a point of controversy, and lay Christians everywhere struggle with this matter.

Christian economists are no different.  In the context of good stewardship, we ply our skills daily in finding optimal economic models.  Those of us involved in the Wall Street world focus on minimizing risk and maximizing gain in the high-stakes world of investment.  To the extent that we succeed, we do God’s work as stewards of the monetary resources He has given us.

Because of the nature of the charts, illustrations, and other models embedded in this paper, it cannot be published here in its entirety.  Therefore, I have provided an abstract of the paper and a link that will provide you with the complete document.


This paper presents a quantitative investment strategy that is capable of producing strong risk-adjusted returns in both up and down markets. The strategy combines mean reversion and momentum investment strategies to construct a diversified statistical arbitrage approach. The mean reversion strategy decomposes stock returns into market and idiosyncratic return components using principal component analysis. The momentum strategy uses technical trading rules to trade momentumat the industry sector level. Dynamic portfolio optimization is utilized to rebalance exposures as the market environment evolves. The combined strategy was able to generate strong risk-adjusted returns in 2008 as the market declined, and in 2009 as the market rallied. The strategy has proven to be robust across two very different market environments in 2008 and 2009.

Click here to download complete report

James R. Velissaris is a Senior Associate in Investment Research at Arden Asset Management in New York City.  He is a graduate of Harvard with further studies at Columbia in New York.


[1] The Moral Underpinnings of Capitalism:  Is Self-Interest as Bad as it Sounds?

by Walton Padelford, Professor of Economics, McAfee School of Business, Union University

Greed is not good, contrary to Michael Douglas’ famous speech in the movie Wall Street.  Greed has a negative moral connotation and is associated with moral evil.  What about a term like self-interest?  Is self-interest always associated with moral evil, or is there a neutral or even positive use of the term?  It is necessary for us in the business schools to continue to state this issue and discuss it, particularly in the context of liberal arts colleges with high philosophical and ethical content in the core curriculum.       

Our exemplar in economics studies, Adam Smith, certainly did think about this problem, and as holder of the Chair of Moral Philosophy at the University of Glasgow, attempted to arrive at a unifying vision of the good life both in economic and moral terms.  The motive force behind Adam Smith’s economic engine was, of course, self-interest.  This makes the system operate.  It is more or less the spring behind our economic models today.  The operative force in Smith’s moral world was the principle of sympathy or sentiment.  We know these things from reading both The Wealth of Nations and The Theory of Moral Sentiments.  The attempt to reconcile these two motive forces is the so-called Das Adam Smith Problem of German scholarship.  The continuing discussion of Smith’s unifying vision can add a certain moral robustness and earnestness to our basic presuppositions concerning capitalism.            

Smith’s moral universe begins with feeling or sympathy.  He does not see naked reason as capable of apprehending moral goals.  “These first perceptions, as well as all other experiments upon which any general rules are founded, cannot be the object of reason, but of immediate sense and feeling” (Smith, Sentiments, 1966, p. 469).  As persons apprehend moral rules through sense and feeling they are able to place themselves in the position of another person.  They are able to walk a mile in the other person’s moccasins, as it were.  This ability, Smith calls sympathy.  In today’s parlance, we might call it empathy.  “As we have no immediate experience of what other men feel, we can form no idea of the manner in which they are affected, but by conceiving what we ourselves would feel in the like situation” (Smith, Sentiments, 1966, p. 3). 

Sympathy does not always denote a compassionate and benevolent feeling toward our fellows.  Sympathy is simply an ability to understand or feel to a certain degree the passions which motivate others, whatever those passions might be.  We might be able to sympathize with passions of love and benevolence or pride and vanity.  So with this definition of sympathy, it is possible for men to be motivated by self-interest, as Smith emphasizes in The Wealth of Nations, and also to sympathize with the motives of self-interest in others.  However, humans are not exclusively self-interested creatures; not the homo economicus caricature of principles of economics courses.  “How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it” (Smith, Sentiments, p.3). 

In Smith’s view, man is a complicated being.  Joseph Cropsey comments: “We are able to gather, therefore, that if we use ‘altruism’ and ‘egoism’ in their literal sense, man can be described, according to Smith, as being by nature altruistic and egoistic—a species member moved by love of self and fellow feeling with others’ (Cropsey, 1972, p. 613).

Our ethical sense is learned through our own sense and feeling.  It is then sharpened through social interaction not through a necessarily innate moral faculty.  Without society there can be no growing knowledge of morals.  The society of others regulates our own extreme passions as we consider the views of others.  Our passions and viewpoints tend to be brought into accord with the rest of society by the operation of sympathy.  This process develops our ability to make moral judgment. 

Glenn Morrow comments here; “The moral world is something independent of the individual thinker.  His moral judgment is based, not upon an inner intuition of rational truth, nor upon a divine revelation, but upon the reflected sentiments of himself and those of his fellow-men, mutually supporting and influencing one another, produce the objective order of moral standards” (Morrow, 1923, p.33).  What is being said here is that Smith’s analysis of morals depends on society itself to produce moral standards.

Vigorous human interaction provides the context for self-interested and benevolent human motives.  These motives exist side-by-side within the same person.  Commercial activity and moral apprehension are developed in society.  There seems to be an invisible hand at work in both spheres.  We are quite familiar with the invisible hand of Adam Smith, but perhaps there is a Smithian invisible hand at work in the area of ethical development as well.

In addition to the principle of sympathy or fellow-feeling, Smith brings in the impartial spectator by which our own conduct may be judged.  This impartial spectator is an imaginary onlooker who approves or disapproves our actions.  “We endeavour to examine our own conduct as we imagine any other fair and impartial spectator would examine it.  If, upon placing ourselves in his situation, we thoroughly enter into all the passions and motives which influenced it, we approve of it, by sympathy with the approbation of this supposed equitable judge” (Smith, Sentiments, p. 162).

Through human interaction and the operation of sympathy and an appeal to the impartial spectator, certain virtues are approved by us such as prudence, justice, and beneficence.  Prudence has specifically economic connotations and makes economic activity a part of the virtuous life.  Smith states; “The care of the health, of the fortune, of the rank and reputation of the individual, the objects upon which his comfort and happiness in this life are supposed principally to depend, is considered as the proper business of that virtue which is commonly called prudence” (Smith, Sentiments, p.311).  Prudence has a good ethical connotation.  Prudence means doing the right thing at the right time, paying attention to detail, and being punctual.  “When the greater part of people are merchants, they always bring probity and punctuality into fashion, and these, therefore, are the principal virtues of a commercial nation” (Smith, Lectures, p.255).

Prudence, in Smith’s worldview, may be the virtue that links successful business action with pleasing moral action.

Justice consists of those basic sanctions that prevent injury to the populace (Smith, Lectures, p. 3).  Beneficence is the most attractive of the virtues.  It is freely exercised and cannot be forced.  It is the crowning virtue which sympathy and the impartial spectator recommend.  “The man who acts according to the rules of perfect prudence, of strict justice, and of proper benevolence, may be said to be perfectly virtuous” (Smith, Sentiments, p.349).  

Smith is a realistic analyst of human behavior.  Along with his optimistic view of economic progress and ethical development through human interaction, he recognizes negative effects that self-interest may produce..  Monopoly and exploitation are clear human possibilities.  The consequence, of course, is that government must make wise policy to limit the pernicious effects of monopoly.  “Monopoly, besides, is a great enemy to good management, which can never be universally established but in consequence of that free and universal competition which forces everybody to have recourse to it for the sake for self-defence” (Smith, Wealth, vol. I, p.165).

A.M.C. Waterman comments on The Wealth of Nations:    “If agents act with regard to their own interest, they will collude whenever that seems likely to improve their relative position….Some legislative reform, of course, will do good, in particular, the dismantling of legal monopolies and other trade restrictions” (Waterman, Economics, p.914)

Smith also recognizes the pernicious effects of commercial development on education of the lower classes of society.  Families seek monetary advantage by putting their children to work at early ages rather than sending them to school.  This early money-earning by young people also tends to weaken parental authority, and in general to weaken the courage of the populace.  Smith leaves the door open here for wise government policy to redress these negative fallouts from unlimited self-interest.  “To remedy these defects would be an object worthy of serious attention” (Smith, Lectures, p.259).  “Though the state was to derive no advantage from the instruction of the inferior ranks of people, it would still deserve its attention that they should not be altogether uninstructed….An instructed and intelligent people besides, are always more decent and orderly than an ignorant and stupid one” (Smith, Wealth, vol. II, pp. 308-309)

Self-interest operating in Smith’s system of natural liberty produces economic growth, and through the invisible hand produces public good.  However, the pull of riches and wealth is very great, and “The great mob of mankind are the admirers and worshippers, …of wealth and greatness” (Smith, Sentiments, p.85).  Smith could applaud the extension of liberty if wealth and greatness were the ultimate ends of man’s activity, but this is clearly not his view.  “…wealth and greatness are mere trinkets of frivolous utility, no more adapted for procuring ease of body or tranquility of mind, than the tweezer-cases of the lover of toys;…” (Smith, Sentiments, p. 261).

What then is the end of Smith’s system?  What is the telos, the end toward which humans are striving?  James E. Alvey comments on the Smithian goals for human beings which are ease and tranquility.  Ease means ease of body, and tranquility means ease of mind.  Mere self-preservation is not enough for the good life, but self-interest would cause us to seek comfortable preservation (Alvey, Natural Foundation, p. 341).  The virtue of prudence which commercial life fosters would also be rewarded with comfortable preservation.  The goal of comfortable preservation would also recommend the virtue of justice in order to maintain public order, enforce contracts, and also engage in redistributive activities.

Commercial life and easy sociability can encourage the life of tranquility or ease of mind.  Tranquility is found in an even temper, in the equable disposition of a man of the world.  “Society and conversation, therefore, are the most powerful remedies for restoring the mind to its tranquility, if, at any time, it has unfortunately lost it; as well as the best preservatives of that equal and happy temper, which is so necessary to self-satisfaction and enjoyment (Smith, Sentiments, p. 25).

The good life is thus a possibility for the whole of society including the middling and lower classes.  Self interest is not as bad as it sounds because it produces economic growth which leads to ease of body.  Commercial society also produces the virtues of prudence and justice and perhaps tranquility of mind also

“In the middling and inferior stations of life, the road to virtue and that to fortune, …are, happily, in most cases very nearly the same.  In all the middling and inferior professions, real and solid professional abilities, joined to prudent, just, firm, and temperate conduct, can very seldom fail of success….In such situations, therefore, we may generally expect a considerable degree of virtue; and, fortunately for the good morals of society, these are the situations of by far the greater part of mankind” (Smith, Sentiments, p.86).

Works Cited

 Alvey, J. E., (2004).  “The Secret, Natural Theological Foundation of Adam Smith’s Work,” Journal of Markets and Morality.  Vol. 7 No. 2.

 Cropsey, J. & Strauss, L. (1972). History of Political Philosophy. Chicago: Rand McNally and Company.

 Morrow, G. R. (1923). The Ethical and Economic Theories of Adam Smith.  New York:             Longmans, Green, and Co.

 Smith, A. (1896). Lectures on Justice, Police, Revenue and Arms. New York: (Reprint, 1964), Augustus M. Kelley, Bookseller.

 Smith, A. (1966). The Theory of Moral Sentiments. New York: Augustus M. Kelly.

 Smith, A. (1976). An Inquiry into the Nature and Causes of The Wealth of Nations.  Chicago: The University of Chicago Press.

 Waterman, A.M.C. (2002). “Economics as Theology: Adam Smith’s Wealth of Nations”  Southern Economic Journal. Vol 68  No. 4.

Dr. Padelford, who has taught at universities in Mexico and Bolivia, is now Professor of Economics at the McAfee School of Business Administration at Union University, Jackson, TN.

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