Profitability of a long-short market neutral strategy utilizing volatility filter rules: A study on the introduction of Shse-Szse CS1300 index futures

This paper studies the profitability of a volatility confirmation filter applied to long-short market neutral trading strategies simulated in the Chinese stock market with the introduction of CSI300 index futures. The market neutral trading strategy is simulated as a trader goes long a tracking portfolio replicating an enhanced benchmark that outperforms the CSI300 index, while go short a corresponding CSI300 futures contract at the same time. The profitability of a long-short market neutral thus requires tracking portfolios rebalanced frequently to maintain high tracking efficiency. However, transaction costs could easily offset all profits if rebalancing is too often. In this paper, we propose a dynamic rebalancing scheme where the underlying market volatility functions as a timing device and tracking portfolios axe only rebalanced when the underlying volatility changes regime. Empirical results show that the addition of such a volatility rebalancing filter improves the trading performance of all long-short market neutral strategies studied in terms of average return and risk-adjusted information ratio.