Blog - Investing Notes
Blog Synthesis: Big Ideas for Investing/Trading
We intend that the entries in this blog convey ideas and research results of lasting value. Here is a listing of past entries that offer some big ideas relevant to investing and trading.
A Better Three-Factor Model? ...>investors who pick stocks may want to focus on two firm characteristics: (1) investment-to-assets ratio; and, (2) return on assets. Evidence indicates that these two characteristics are foundational to a broad range of stock return anomalies.
The Required Yield Theory of Asset Valuation ...the Required Yield Theory supports Jeremy Siegel's assumption that "investors bid stock prices up or down in response to changing taxes and inflation to obtain the same after-tax real return."
Some Best Guesses on What Works Best ...momentum and value strategies applied at the asset class level via low-cost funds may be among the best for individual investors.
Persistence of Diversity in Investor/Trader Beliefs ...while financial markets may be adaptive, the adaptive process appears to be very messy, strongly preserving a wide diversity of investor/trader beliefs. Anomalies can persist.
Financial Instability Hypothesis ...investors may want to consider the cycle of stability, instability and collapse proposed via the Financial Instability Hypothesis (though unquantified) in judging the state of financial markets.
Optimal Asset Class Allocations ...investors with low-middle risk tolerance may accrue significant diversification benefits from adding proxies for real estate, commodities and high yield bonds to traditional portfolios of stocks, government bonds and cash.
Beat the Market with Hot-Anomaly Switching? ...a trader who periodically switches to the hottest known anomaly based on a rolling window of past performance may be able to beat the market. Anomalies appear to have their own kind of momentum.
Surviving by Staying Out of the Fourth Quadrant ...the way to survive the fat-tailedness of investment returns is through limiting exposure to such investments.
Four Factors and Two Regimes ...equity investors may want to alternate between momentum and value investing styles as the overall stock market varies from low-volatility to high-volatility states.
The Achilles' Heel of Pre-determined Lifecycle Funds? ...lifecycle investors will generally achieve greater terminal wealth using interim success-based dynamic stocks/fixed income allocation rules than using pre-determined shifts away from stocks and toward fixed income.
Predictable Pieces of the Market? ...investors/traders may be able to enhance market timing results by focusing on the most predictable styles/industries (for example, via exchange-traded funds).
Sector Rotation vs. Stock Picking ...among a broad sample of actively managed mutual funds, stock picking makes a greater contribution to returns than sector allocation. The average contributions to fund returns from market-sectors-stocks are 79%-9%-12%.
Different Paths to the Same (Disconcerting) Destination? ...The Efficient Market Hypothesis and the "Black Swan" Hypothesis take very different paths to the same destination...
Stock Returns for New Industries ...Raw stock returns for firms in new U.S. industries tend on average to be positive and substantial, but very concentrated among a few companies. Risk-adjusted returns for new industries mostly match or underperform the broad U.S. stock market over their first 15-20 years.
A Factor Fishing Expedition ...investors should probably use the excess market return (beta), size and liquidity factors in explaining and predicting individual stock returns, but not the book-to-market ratio (value factor) or other commonly used stock/firm-specific factors.
Long-term Market Timing Model Flyoff ...long-term stock market timing models may enhance investment returns, especially on a risk-adjusted basis. Which model is best depends on the risk-adjustment metric used.
The Fourth Quadrant: No Realm for the Normal ..."normal" statistical metrics and associated risk management methods do not work in the realm of Black Swans (including financial markets). Redundancy, not optimization, helps manage risk in this realm.
The Sensitivity of Stock Market Return Predictability to Predictor Measurement Interval ...equity returns may react quickly to some predictors and slowly to others, and they may respond most strongly to short or extended predictor movements. "Standardized" approaches to predictor interval measurement may not work.
Anomalies Tested with Expected (Rather Than Historical) Returns ...the well-known stock market anomalies may be much less reliable in rational practice than they appear in hindsight.
The Futility of Timing Emerging Equity Markets? ...very small numbers of extreme return days have a massive impact on long-term stock returns in emerging markets. The naive probability of predicting which days will be extreme is very low.
Quantitative Finance in a Nutshell ...quantitative finance is an emphatically empirical field focused on finding bargains by comparing the prices of similar assets, and safely skimming returns from these bargains.
Why the Story on Predictability Keeps Changing ...the ability of commonly used indicators to predict near-term (one-month) stock market returns appears during economic recessions (periods of high return volatility) but vanishes during economic expansions.
The Cost of Hope? ...the average investor in U.S. equities could boost annual returns by roughly 0.67% by switching from an active strategy to a passive one.
Extracting Disaster from Index Option Prices ...pricing of out-of-the-money put options for the S&P 500 index indicates that investors expect 50% stock market crashes every 50 years.
Institutional Trading, Returns and Strength of Anomalies ...evidence suggests that stocks with low institutional trading activity (distinct from institutional ownership) tend to be overpriced, with amplified return anomalies.
Fama and French Dissect Anomalies ...some anomalies are stronger and more consistent than others. Momentum appears to be the strongest and most consistent.
Modernizing Equity Return Benchmarks ..."expect more dynamic strategies [such as 130% long/30% short] to become passive benchmarks as the investor base becomes more sophisticated and demanding."
The (Worldwide) Futility of Market Timing? ...a few outlier trading days have a massive impact on long-term stock returns, and attempting to forecast which days is a fool's errand.
Recent Speculations on Prediction Markets ...Some eminent economists and political scientists believe that prediction-information-decision markets offer significant benefits to society through efficient extraction and consolidation of the knowledge of individuals. They may also offer some insights into the workings of traditional financial markets that have evolved from trading.
A Different Factor Model for Each Group of Stocks? ...while dominant factors may common, different groups of stocks require different factor models to explain the variation in returns among individual stocks within them.
A Five-Factor Model of Differences in Stock Returns ...a five-factor model effectively explains differences among individual stock returns, with volatility of past returns at least as important as size, value and momentum factors.
When the Going Gets Tough, the Predictive Power Gets Going? ...because the most informed players have the latitude to delay showing their hands during business expansions, the power of widely used indicators of future stock returns emerges predominantly during recessions.
Calibrating Ancient History ...a dynamic and flexible model of long-term equity returns that accommodates structural breaks improves predictive power, at the cost of considerable complexity.
Organizing Financial Markets Research ...the uses of empirical research on financial markets derive in large measure from sampling frequency (supporting either short-term or long-term prediction) and sample duration (supporting either reliable or unreliable inference).
Some Notes on Financial Econometrics ...financial econometrics does not yet have its Hari Seldon.
Evolution of the Efficient Markets Hypothesis ...the Efficient Markets Hypothesis is arguably evolving to incorporate genetic material from the theories of psychology, games, learning and biological evolution.
A Survey of the Factor Landscape ...there is considerable redundancy and invalidity among the many factors used to explain differences in returns among individual stocks. Three factors may be necessary and sufficient, with liquidity the most influential.
Investors as Social (Relative Wealth) Climbers ...status may be more powerful than wealth as a motivator, with significant implications for investor/trader behavior.
The Ignored-by-the-MSM (Information Risk) Premium? ...there is an "information risk premium" such that stocks not covered by the news media yield significantly higher future returns than stocks heavily covered, even after accounting for other widely used risk factors.
The Sharpe Ratio: Blunted by Noise? ...the Sharpe ratio has such a high level of intrinsic variability that it is not a very reliable portfolio comparison tool.
Quantifying and Exploiting Long (Bull and Bear) Trends ...portfolio management based on statistically reliable characterization of the long-term trend of the stock market offers an economically significant advantage over approaches that ignore the long-term trend.
Technical Analysis as Folk Medicine ...the incorporation of folk medicine by pharmacology offers a model for bringing technical analysis into the financial economics fold.
Global Diversification: By Country or Industry? ...global integration is rapidly shifting the balance of diversification power from countries to industries (for investors who adhere to modern portfolio theory).
Eight Simple Rules from Financial Market Research ...we offer here a few rules upon which one can depend...
Where Has All the News Gone? ...a simple information processing view of the stock market offers an interesting explanatory framework, but little predictive power.
The Entropic Markets Hypothesis ...this synthesis of the theories of physical entropy, information processing and evolution offers an interesting perspective on investor psychology and financial market behavior.
Collective2: A Marketplace of Trading Systems ...the aggregate performance of the stock trading systems active on Collective2 is not inconsistent with the Efficient Market Hypothesis.
Explaining Large Stock Market Fluctuations ...the power law distribution of sizes of large investors, along with the optimal trading behavior of those investors, explains the excess volatility observed in asset markets.
The Decline of Stock Picking? ...investors everywhere have increasingly embraced modern portfolio theory, emphasizing risk management (diversification) over stock picking. The best opportunities for (diligent) stock pickers are the stocks of young, small, obscure, foreign firms.
Dow Theory Long Dead? Not So Fast, My Friend ...the Dow Theory has generated excess risk-adjusted (but not raw) returns when compared to buy-and-hold over some significant periods by following large trends.
Demography and the Stock Market ...demographic trends suggest a headwind for U.S. equities over the next 15 years. Baby Boomers may drive P/Es down as they sell to fund retirement.
Fooled by Consciousness ...We cannot completely trust what we tell ourselves, let alone what others tell us.
Survival of the Richest: The Adaptive Markets Hypothesis ...competition, mutation, reproduction, and natural selection...determine the level of market efficiency and drive the evolution of the financial industry...
The (Stock Market) Modeling Life ...If your crystal ball has not been working so well...
Returns for Investors (Rather Than Markets) ...the actual aggregate (timing) experience of equity investors is inferior to passive buy-and-hold stock market returns. An active approach of buying after pronounced capital outflows from the market and selling after pronounced capital inflows to the market is likely to be successful.
One Up on the Fed Model? ...individual investors may be able to outperform through determined reinvestment of dividends and exploitation of capital gains mean diversion and reversion.
Reversion to Something ...stock market returns fluctuate away from, and revert to, a running mean on a roughly annual basis.
Randomly Walking in Circles? ...the stock market is inexploitably efficient.
