Signal Decay and the Backtest-Live Gap
Suppose the research was clean: no leakage, honest validation, deflated for trials, costed at size. The final fact of life is that the measured edge is a snapshot of a market that reacts to being traded. Edges decay, and live performance systematically undershoots even honest backtests. A researcher who cannot explain why is reciting; one who can is ready to run money.
Why edges decay
Crowding. Anomalies published in journals or discovered independently attract capital, and the act of harvesting a mispricing shrinks it. The empirical literature on published anomalies finds large post-publication performance declines, and the mechanism is simply competition.
Adaptation. The counterparties funding the edge (hedgers paying premia, constrained institutions, predictable flows) change behaviour, renegotiate, or disappear. Structural edges last as long as the structure.
Regime change. An edge fitted to one volatility, rate or liquidity regime can be genuinely real and still stop working when the regime does, which is a validated-then-fails outcome that no amount of historical rigour prevents.
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