Explain active approaches that exploit statistical arbitrage and the workings of market microstructure
The idea
Statistical arbitrage uses quantitative models to find temporary mispricings between related securities and bets that they will revert. The standard example is pairs trading: two historically co-moving stocks are identified, and when their price spread widens abnormally the manager buys the cheap one and shorts the rich one, closing when the spread returns to normal. Mean reversion is the core assumption, so the key risk is a structural break that lets the spread keep widening. Market microstructure strategies exploit very short-term patterns in order flow, liquidity and prices across venues. Both need heavy investment in technology, tight cost control and many small, independent bets. The trap is overlooking transaction costs, which can erase the thin edge on each trade.
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