If it is possible for bubbles to arise in frictionless circumstances, then it follows that any theory that treats bubbles as the consequence of friction is, at very best, incomplete. And that is important to know especially if policy makers are busy drawing their own conclusions from those incomplete-or-worse theories.
CAPM / Alpha Theory
Presumably the U.S. Supreme Court's decision, in December 2008, that states can in fact make and enforce tougher labeling standards for cigarettes than does the federal government was a negative for tobacco stocks. But did that mean that stock prices had already anticipated the decision before it happened? or that they immediately adjusted downward on the morning the decision was announced? Or ... neither of those?
As regular readers of this blog may recall, I have found much to admire in the writings of Nassim Nicholas Taleb. So I am happy that he had decided to put some distance between himself and a recent claim that Universa made $1 billion when bad news from China shook the world's markets in late August.
The authors of a new study of the relationship between fund size and performance employ a database consisting of 7,261 funds and their performance over a twenty year period (1994 to 2014). Spoiler alert: size is bad. Especially in a crisis.
Last year the Conference Board asked itself several questions germane to corporate governance. They were good questions. The odd thing about the report was the way the greybeards involved simply threw up their hands rather than trying to answer any of them.
Two authors at EDHEC remind us that 15% of the assets in any ETF or ETF-like products for European investors were in smart-beta indexed products as of August 2014, and that this amount is growing. They discuss the extent to which investors are pleased with their results.
Guest columnist Andrew Beer looks at alpha.
A new report finds that firms where current public officials are destined to become employees outperform other private firms by 7.43% per year during the three years before the officials/employees pass from one post to the other. The outperformance is highest in the year immediately before the switch, Justas a cynic looking for corrupt quid pro quos would suspect.
The hapless U.S. mutual funds Chen and Gallagher sample have a nominally positive pre fee alpha only when measured against CAPM. That disappears into the negatives when the baseline used is the Fama-French model, and deeper into the negatives when the momentum factor is added.
There have been "a considerable number of product launches in the area of smart beta ETFs," but investors are eager for more, perhaps in the hope the developers will get beyond the "few popular strategies" in that area on which they have so far focused. With more variety may come a real take-off.
The first half-hour return of the S&P 500 ETF predicts the last half-hour return of the same trading day rather well. Why isn't this effect arbitraged away and a random walk restored?
Regular readers of AllAboutAlpha know that Bayesianism, a movement with the world of probability and statistics, has a good deal to do with contemporary pricing models and portfolio theory. It also has foes in that world, the frequentists, and a 2012 cartoon, recently raised to salience again by a Facebook post, has given those frequentists reason to gripe about Bayesian smugness.
A new paper by a senior market economist at BNP Paribas celebrates the invention of Learning Vector Quantization (LVQ), a machine-learning algorithm that could enable some smart economists to get very rich indeed.
A new paper by Eric Falkenstein discusses an old question: the reason for the high risk-adjusted return in low-risk equities, and the adjustments it requires in CAPM. This is no fleeting oddity, but a lasting characteristic of markets. In econo-speak, not only the existence but the persistence of the anomaly requires explanation.
A regime switching model may treat a high-volatility environment as one “regime,” and a low-vol environment as its successor regime. The idea, as it applies to risk management, then, is simply to be ready in either setting for the switch to the other. This is both playing defense and playing offense. It is both managing risk and pursuing alpha.
A new paper by a scholar at the McCombs School of Business looks at what causes what on Wall Street, starting with how (if at all) analyst downgrades cause price declines.
Christopher Faille, inspired by Greg Richey, of California State University, San Bernardino, has a few words about socially irresponsible investing, that is, the creation of a portfolio built around destructive human vices.
Despite what the title (Deflating the Sharpe Ratio) might cause a naïve observer to suspect, de Prado's recent presentation was more pro than con the ratio in question. Mend it, don't end it.
The stakes, for mathematics, finance, and the overlap of the two, are pretty high. So my ears pricked up when I heard of a sweeping challenge to Bayesianism.
It does appear that speed is helpful in generating alpha. How is it helpful? Here there are two views, and the less HFT-friendly of these views has received some scholarly/empirical support.
Starting with 350 available metrics of corporate governance and/or forensic accounting, GMI Ratings has boiled their model down to just 64, and from those they get three scores.
An aphorism of Warren Buffett's once again making the rounds can be understood in at least three distinct ways. Faille looks at the possible constructions and decides that, whatever exactly Buffett meant to say or do, his reasoning here does little harm to his target, modern finance theory.
A recent survey of firm-valuation experts from 10 European countries indicates that they can produce wildly different values given the same inputs. Okay: maybe that’s not too surprising. Any valuation model will necessarily include parameters that will in turn require a best-guess approach, often as subjective in inspiration as it is objective in aspiration. So […]
I admire a new "direct alpha" approach to measuring the success of PE portfolios. So will anyone who has had to tell a friend or loved one, "just come out and ask me please!"
That gadfly of financial modelers and quants is back. This time, Taleb writes in such a way as to establish that he isn't a mere popularize/diluter of familiar academic arguments -- which is how the critics of many of his earlier books have painted him. And them.
A recent paper on "Option Implied Volatility, Skewness, and Kurtosis and the Cross-Section of Expected Stock Returns" finds a positive relationship between each of the three listed characteristics of a distribution on the one hand and ex ante expected returns on the other. In the case of skewness in particular, this finding struck me as a bit odd.
A new paper addresses a group of industrial metals, the platinum group, and suggests that its components might be a wise addition to many portfolios on CAPM grounds.
The success of low-volatility strategies has been noted in the literature at least since the mid-1970s, with the publication of a seminal work by Haugen and Heins. And such strategies continue to prove successful today. Why do they still work? Why don't the excess profits draw in the bears, consuming all the picnic baskets, driving profit levels down to normal?
A strategy based largely on stop-loss and stop-gain rules, one that uses such rules as the sole means of shifting assets from one asset class to another, can earn statistically significant CAPM alpha, according to a provocative study from the University of Arizona.
Under standard portfolio theory assumptions, it takes three times longer to recover from the maximum draw-down for a particular strategy than it does to get there. Fortunately, those assumptions seem to be wrong in a way that allows for a more rapid return to a high water mark.
Asness, Frazzini and Pedersen produce data indicating that over a long period in the U.S., a regular bet-against-beta strategy, one not designed either to accentuate or to eliminate differences among the different industries represented in the portfolio, earned CAPM alpha of 0.73.
A portfolio becomes optimal by virtue not merely of what assets are in it, but by virtue of what is paid for each. Examining the implications of that point, Professor Johnstone finds a "logical circularity built into the CAPM equilibrium pricing mechanism."
D.J. Johnstone of the University of Sydney Business School tells us that if we understand Bayesian probability theory, we'll see that even a very informative signal can bring an increase in uncertainty, thereby raising the cost of capital. This is at least a little bit counter-intuitive, offending the verities about how wonderful is transparency.
Intuition (codified by many models) suggests that investors have to be bribed to accept risk, so that there ought to be a positive link for any given class of security between the amount of risk, and thus the measurement of volatility, on the one hand, and expected return on the other. A puzzle arises, then, from empirical research indicating that “idiosyncratic” volatility, that is, the volatility due to the characteristics of a specific security, is negatively correlated with return once one passes the mid-point of the range of volatility.
By Christopher Faille A presentation by Samuel Kunz, chief investment officer of the Policeman’s Annuity and Benefit Fund, Chicago, to the CFA Institute 2011 Asset and Risk Allocation conference addressed the pros and cons of “risk parity.” His presentation makes it seem that risk-parity portfolios (RPP) and the Capital Asset Pricing Model (CAPM) are sibling […]
A perfectly "hedged" fund is one which has no downside risk. Its payoff relative to the market or some other benchmark is the same as that of the fund plus a put option that provides protection against the downside. In the real world...
Alpha not “dead” – just not always better than beta (as long as you’re sure about the future direction of markets of course)May 1st, 2011 | Filed under: CAPM / Alpha Theory, Today's Post
A recent research note concludes that alpha (as a performance measure) passed away recently after along battle with beta-tosis and several other ailments. But wait! Did Alpha's nose just twitch?
If only the marketplace for alpha fit neatly into a model from an Economics textbook.
New spin on the Fundamental Law of Active Management finds US mutual funds were “a victim of their own success”Mar 31st, 2011 | Filed under: CAPM / Alpha Theory, Real Estate, Today's Post
Finally, a version of the Fundamental Law that fundamental managers can actually use. But be forewarned, if you're a fundamental mutual fund manager, you won't like what it has to say...
Think your basket of thousands of stocks is the most diversified portfolio possible? Maybe not...
In the never-ending search for the source of hedge fund alpha, some have looked to factor timing. But a new study suggests that this, like many other possible explanations, falls short of explaining the hedge fund secret sauce.
Managers operating in mature and “efficient” markets rejoice! Study finds you too can generate alpha.Feb 22nd, 2011 | Filed under: Academic Research, CAPM / Alpha Theory, Today's Post
Thought managers in "inefficient markets" like emerging markets or small cap equities had the advantage when it comes to alpha-generation? Maybe not...
If a recent study of French institutional investors can be applied to a recent report on US equity markets, alpha opportunities abound for years to come.
Success breeds success – and expectations of continued success. Except in private equity, where success bodes reversion to the mean, a recent study on performance persistence argues.
A transnational study of mutual funds sheds light on one of the secrets of hedge funds' overall success.
Pop Quiz for Long/Short Equity Investors: When does a high “up-capture” not cost you a commensurately high “down-capture”?Dec 7th, 2010 | Filed under: CAPM / Alpha Theory, Today's Post
The dream long/short equity fund is one that has a high market "up-capture" with little or no market "down-capture". But how do you find your dream fund when up-capture and down-capture fluctuate all the time? Here's one innovative idea...