Abstract
Wall Street brokers and portfolio managers frequently use regressions of spread levels on contemporaneous market variables to perform relative value analysis. The regression residual is intended to capture market disequilibrium. If one expects the disequilibrium to be resolved, future spread changes can be inferred from the residual. This approach has two shortcomings. First, no explicit prediction of the spread change over a fixed horizon is made. Second, the spread is expected to revert to the fitted value of the rich/cheap levels regression only if the
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