Volume 8, Number 3 Third Quarter 2010 View PDF… Read more
2010
PRACTITIONER’S DIGEST
Volume 8, Number 3, Third Quarter 2010 View PDF… Read more
BOOK REVIEW: The Little Book of Safe Money / The Little Book of Bulletproof Investing
Volume 8, Number 4, Fourth Quarter 2010 The Little Book of Safe Money Jason Zweig Reviewed by Javier Estrada The Little Book of Bulletproof Investing Ben Stein and Phil Demuth Reviewed by Javier Estrada View PDF… Read more
CASE STUDIES: Linear Causality
Jack L. Treynor Volume 8, Number 4, Fourth Quarter 2010 View PDF… Read more
What’s the Best Way to Trade Using the January Barometer?
Michael J. Cooper, John J. McConnell and Alexei V. Ovtchinnikov Volume 8, Number 4, Fourth Quarter 2010 According to Streetlore, as embedded in the adage “As goes January so goes the rest of the year,” the market return in January provides useful information to would-be investors in that the January market return predicts the market… Read more
The Rule of 72 for Lifetime Savings
Thomas K. Philips Volume 8, Number 4, Fourth Quarter 2010 Financial planners often impress upon their clients the power of compounding by quoting them the Rule of 72: With annual compounding, a dollar invested in an investment account at a constant interest rate of r% per annum grows to two dollars in approximately 72/r years… Read more
How Quickly Do Equity Prices Converge to Intrinsic Value?
Dennis R. Capozza and Ryan D. Israelsen Volume 8, Number 4, Fourth Quarter 2010 This research hypothesizes that in markets where information costs, transactions costs and the economic impact of information can vary widely, we should expect both significant predictability and systematic variation in the predictability. Controlling for other factors, we find that on average… Read more
Equally Weighted Rebalancing as the Average of all Investment Strategies
Masahito Shimizu Volume 8, Number 4, Fourth Quarter 2010 In a performance evaluation, it is important for both sponsors and portfolio managers to estimate the opportunity set of possible performances. In this regard, we investigate the average performance of all possible strategies and how performance varies across strategies. We show that the average is equal… Read more
SURVEYS AND CROSSOVERS: Implementing Option Pricing Models Using Python and Cython
Sanjiv R. Das and Brian Granger Volume 8, Number 4, Fourth Quarter 2010 In this article we propose a new approach for implementing option pricing models in finance. Financial engineers typically prototype such models in an interactive language (such as Matlab) and then use a compiled language such as C/C++ for production systems. Code is… Read more
INSIGHTS: A New Taxonomy of the Dynamic Term Structure Models
Sanjay K. Nawalkha, Natalia A. Beliaeve and Gloria Soto Volume 8, Number 4, Fourth Quarter 2010 This paper gives a new taxonomy of dynamic termstructure models (TSMs) that classifies all existing TSMs as either fundamental models or preference-free single-plus, double-plus, and triple-plus models.We exemplify the new taxonomy by considering preference-free versions of some well-known fundamental… Read more
PRACTITIONER’S DIGEST
Volume 8, Number 4, Fourth Quarter 2010 View PDF… Read more
BOOK REVIEWS: This Time is Different: Eight Centuries of Financial Crisis
Volume 8, Number 3, Third Quarter 2010 This Time is Different: Eight Centuries of Financial Crisis Carmen M. Reinhart and Kenneth S. Rogoff Reviewed by Bruce Grantier View PDF… Read more
CASE STUDIES: Momentum Stocks
Jack L. Treynor Volume 8, Number 3, Third Quarter 2010 View PDF… Read more
An Improved Implied Copula Model and Its Application to the Valuation of Bespoke CDO Tranches
John Hull and Alan White Volume 8, Number 3, Third Quarter 2010 In Hull and White (2006) we showed how CDO quotes can be used to imply a probability distribution for the hazard rate over the life of the CDO. This is known as the implied copula model. In this paper we develop a parametric… Read more
CROSSOVERS & SURVEYS – The Libor/SABR Market Models: A Critical Review
Sanjay K. Nawalkha Volume 8, Number 3, Third Quarter 2010 This paper reviews the LIBOR market model (LMM) and the LMM-SABR model. While a plethora of interest rate models, such as fundamental models, single-plus models, double-plus models, and triple-plus models, can be used for valuation of plain vanilla derivatives, only a few models such as… Read more
Do Informed Investors Cause Momentum?
James H. Scott and Jorge A. Murillo Volume 8, Number 3, Third Quarter 2010 We show that there will be expected momentum in stock returns if there are informed and uninformed investors, and if informed investors know the mean of the stocks future fundamental value. We use analysts estimates to construct a truncated valuation formula… Read more
A Bayesian Approach to Stress Testing and Scenario Analysis
Riccardo Rebonato Volume 8, Number 3, Third Quarter 2010 I present a new approach to stress testing that combines the elicitation of subjective (marginal or conditional) probabilities of events with the specification of a simple causal structure among them. By so doing, stress events are placed in an approximate but coherent probabilistic framework. The approach… Read more
The Asset Growth Effect in Stock Returns
Michael J. Cooper, Huseyin Gulen and Michael J. Schill Volume 8, Number 3, Third Quarter 2010 We document a strong negative relationship between the growth of total firm assets and subsequent firm stock returns using a broad sample of U.S. stocks. Over the past 40 years, low asset growth stocks have maintained a return premium… Read more
INSIGHTS: Some Lessons Learned in 42 Years of Business
Charles E. Harris Volume 8, Number 3, Third Quarter 2010 From 1984 to 2008, I had the pleasure and privilege of serving as Chairman and CEO of Harris & Harris Group, LLC, a publicly traded venture capital firm based in New York. Upon my retirement, I decided to summarize lessons I learned in my 42… Read more
BOOK REVIEWS: Active Credit Portfolio Management in Practice
Active Credit Portfolio Management in Practice Jeffrey R. Bohn and Roger M. Stein Reviewed by Cel Kulasekaran View PDF… Read more
CASE STUDIES: Household Risk
Jack L. Treynor Volume 8, Number 2, Second Quarter 2010 View PDF… 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
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… 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
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, and it permits us to start with a clean slate… Read more
INSIGHTS: 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
BOOK REVIEWS: Guide to Investment Strategy: How To Understand Markets, Risk and Behaviour
Volume 8, Number 1, First Quarter 2010 Guide to Investment Strategy: How To Understand Markets, Risk and Behaviour Peter Stanyer Reviewed by Elroy Dimson View PDF… Read more
CASE STUDIES: Global Investing
Jack L. Treynor Volume 8, Number 1, First Quarter 2010 View PDF… Read more
Non-Normality Facts and Fallacies
David N. Esch Volume 8, Number 1, First Quarter 2010 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… Read more
New Directions in Financial Sector and Sovereign Risk Management
Dale Gray and Andreas A. Jobst Volume 8, Number 1, First Quarter 2010 The global financial crisis that began in 2007 has forced a re-examination of macroeconomics, financial economics, regulation, and risk management. Traditional macroeconomics overlooks the importance of risk which makes it ill-suited to analyze risk transmission, contagion and how risks can build up… Read more
Do Endowment Funds Select the Optimal Mix of Active and Passive Risks?
Keith C. Brown and Cristian Tiu Volume 8, Number 1, First Quarter 2010 The investment decision confronting managers of multi-asset class portfolios can be characterized in terms of the passive (i.e., benchmark or policy) and active (i.e., market timing and security selection) strategies they adopt. In this paper, we investigate whether managers select the appropriate… Read more
The Long View of Financial Risk
Lisa R. Goldberg and Michael Y. Hayes Volume 8, Number 1, First Quarter 2010 We discuss a practical and effective extension of portfolio risk management and construction best practices to account for extreme events. The central element of the extension is (expected) shortfall, which is the expected loss given that a value-at-risk limit is breached… Read more
INSIGHTS: Lessons on Investment Management From the Global Recession and Bear Market
Frank J. Jones Volume 8, Number 1, First Quarter 2010 The current global recession and financial crisis have significantly affected virtually all investment managers. The severity of the effects on investment management risk has induced many investment managers to reconsider their investment approaches in terms of investment management risk. This paper summarizes and evaluates many… Read more