Machine Forecast Disagreement
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Turan G. Bali; Bryan T. Kelly; Mathis Moerke; Jamil A. Rahman
Strategy in a nutshell
The investment universe comprises common stocks trading at the NYSE, AMEX, and NASDAQ. (Exclude financial and U.S. stocks (NYSE/AMEX/NASDAQ, excluding small, illiquid, financial, utilities, and <$5 stocks) are ranked monthly by Machine Forecast Disagreement (MFD) from a random forest model using 130 firm characteristics. Go long the lowest MFD decile, short the highest. Value-weighted and rebalanced monthly.
Economic rationale
Investor disagreement arises from heterogeneous beliefs about firm fundamentals. The long-short MFD portfolio earns alpha primarily due to mispricing, driven by limits to arbitrage, short-sale constraints, and high retail ownership, rather than fundamental risk.
Backtest performance
Annualised return14.57%
Volatility16.97%
Sharpe ratio0.88