Kent Osband Most portfolio risk analysis implicitly assumes that risks are stable, despite copious evidence of instability. This article presents an alternative, “VarGamma”, that provides neat formulas for expected risk-adjusted returns even with stochastic volatility and volatility-dependent drift. VarGamma measures are far more flexible and robust than standard mean–variance formulations or quantiles (VaR), with minimal… Read more
Articles
ESTIMATING THE NEGATIVE IMPACT OF “NOISE” ON THE RETURNS OF CAP-WEIGHTED PORTFOLIOS IN VARIOUS SEGMENTS OF THE EQUITY MARKETS
Russell J. Fuller, Bing Han and Yining Tung Capital Market Theory assumes that the ex ante market portfolio (which is cap-weighted) lies on the (ex ante) efficient frontier. However, we show that ex ante cap-weighted portfolios will always be interior portfolios relative to the end-of-investment-period ex post efficient frontier. This is due to the arrival… Read more
NON-NORMALITY FACTS AND FALLACIES
David N. Esch Recently there has been an increasing trend in the quantitative finance community to call for statistical models which are explicitly model returns with non-normal probability distributions (e.g. Sheikh and Qiao, 2009, Bhansali, 2008, Harvey and Siddique, 2004). In this paper, we explain why summary rejection of normal distributions is almost always ill-advised… Read more
THE POWER TO SPEND
THE FUTURE OF FINANCE
Mark Kritzman The future of finance is bright, if for no other reason, because our financial system failed. This failure raises the level of urgency for developing more realistic models, more effective regulation, and more responsible financial institutions. Moreover, it permits us to start with a clean slate… Read more
THE INEVITABLE BAGGAGE WE DISPLAY
Dean LeBaron Until the point at which investment models began melting, too many investment practitioners operated within a myopic belief system that failed to contemplate certain fundamentals that are rigorously observed in other scientific disciplines. Flaws crept into our research under various headings of convenient simplification, behavioral finance, and statistical tools. Biases influenced our work… Read more
THE STUDY OF CRISES
James H. Scott A study of financial crises can improve our understanding of theories, and of the relative strengths and weaknesses of different institutional arrangements. This article discusses four examples. (1) During the crisis, risk converged towards a global risk factor that dominated secondary risk factors. (2) Value is a secondary risk factor because it… Read more
WARNING: PHYSICS ENVY MAY BE HAZARDOUS TO YOUR WEALTH!
Andrew W. Lo and Mark T. Mueller The quantitative aspirations of economists and financial analysts have for many years been based on the belief that it should be possible to build models of economic systems—and financial markets in particular—that are as predictive as those in physics. While this perspective has led to a number of… Read more
QUANTIFYING SYSTEMIC RISK AND RECONCEPTUALIZING THE ROLE OF FINANCE FOR ECONOMIC GROWTH
Dale F. Gray, Andreas A. Jobst, and Samuel W. Malone Contingent claims analysis (CCA) has formed part of the core of modern financial theory since the early 1970s as basis for many credit risk measurement methods. The adaptation of CCA for the measurement and analysis of systemic risk that arises due to the cross-exposures of… Read more
STOCKHOLDER RIGHTS AND CARL ICAHN
Harold Bierman, Jr. One might conject that shareholder activism should be praised and welcomed by shareholders. This paper suggests that some actions, alleged to be on behalf of shareholders, can be shown to be on behalf of a small group of activist investors, and not for the broader group of stock owners. To investigate the… Read more