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Here's an example by Marco Avellenada from NYU titled "Statistical Arbitrage in the U.S. Equities Market". The idea of this paper involves capturing mean reversion in the residual returns of a security after removing the principle components of return.

As another example, here is some research by Mark Kritzman showing how spikes in the "absorption rate" are associated with drawdowns in the US equity market.

I wonder if there are other strategies involving the eigenportfolios or behavior of principal components other than the dominant eigenvector (i.e. the market portfolio) and non-random eigenvectors.

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up vote 7 down vote accepted

Attilio Meucci does some very interesting things with PCA. See e.g. his paper on managing diversification which makes heavy use of it (and explains it very intuitively along the way):

Managing Diversification by Attilio Meucci

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+1 Thanks - yep I'm a big fan of Meucci. This is on the risk side though, would be great to see research on the Alpha side – Ram Ahluwalia Apr 1 '12 at 18:34
If you are a fan of Meucci, you have surely read this one papers.ssrn.com/sol3/papers.cfm?abstract_id=1404905 – mepuzza Apr 12 '12 at 16:18

If you know R; here is a very good tutorial with practical examples:


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This is more of a tutorial on PCA rather than using PCA to generate alpha – Ram Ahluwalia Apr 6 '12 at 23:44

The Systematic Investor has a series of articles on using PCA and clustering to improve on traditional Risk Parity approaches.

The series of posts start here: http://systematicinvestor.wordpress.com/2012/12/22/visualizing-principal-components/

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