Arik Ben Dor, Ravi Jagannathan, and Iwan Meier We illustrate the use of return-based style analysis in practice using several examples. We demonstrate the importance of selecting the right style benchmarks and how the use of inappropriate style benchmarks may lead to wrong conclusions. For example, when style analysis is applied to sector-oriented funds, the… Read more
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IT’S 11 PM—DO YOU KNOW WHERE YOUR LIQUIDITY IS? THE MEAN-VARIANCE-LIQUIDITY FRONTIER
Andrew W. Lo, Constantin Petrov, and Martin Wierzbicki We introduce liquidity into the standard mean-variance portfolio optimization framework by defining several measures of liquidity and then constructing three-dimensional mean variance- liquidity frontiers in three ways: liquidity filtering, liquidity constraints, and a mean-variance-liquidity objective function.We show that portfolios close to each other on the traditional mean-variance… Read more
ESTIMATING DEFAULT PROBABILITIES IMPLICIT IN EQUITY PRICES
Tibor Janosi, Robert Jarrow, and Yildiray Yildirim This paper uses a reduced-form credit risk model to estimate default probabilities implicit in equity prices. For a cross-section of firms, a time-series regression of monthly equity returns is estimated. We show that it is feasible to infer the firm’s probability of default implicit in equity returns. However… Read more
SEGMENTATION, ILLIQUIDITY, AND RETURNS
Renato Staub and Jeffrey Diermeier When investing in alternative assets, such as private equity or natural resources—which may be “locked-up” for prolonged periods of time—the question of compensation for illiquidity becomes important. No rational investor will choose the illiquid over the liquid asset unless he gets compensated for his loss of flexibility. We derive two… Read more