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Book Preview – Introduction and Chapter 1

Posted in Big Ideas

Starting today and continuing for the next eight Fridays, we are previewing for subscribers a short book entitled Avoiding Investment Strategy Flame-outs.

The initial installments are:

“Introduction”

“Why do investment/trading strategies that test well on historical data flame out when put to actual use? Are there steps investors can take to improve the odds that strategies they develop will perform as tested? This book draws upon reviews of hundreds of academic and practitioner studies that seek to predict asset prices and exploit the predictions. It focuses on widespread weaknesses and limitations in these studies to help investors: (1) avoid or mitigate the weaknesses in developing their own strategies; and, (2) perform due diligence on strategies offered by others.”

Chapter 1: “Some Statistical Practices that Make Sense”

“Financial systems, such as stock markets, involve a large number of interacting decisions based on many different time-varying levels of knowledge, processing capabilities, motivations and financial resources. Due to this complexity, theories of financial system behavior cannot determine future prices and returns. Said differently, the models termed “financial theories” are actually just working hypotheses generally formed retrospectively (empirically) to fit the past.

“Lack of solid theories leaves researchers to explore a jungle of empirical data via statistical inference, constructing samples and looking for past conditions (indicators) that relate strongly to future outcomes (returns) within those samples. Investors then make the leap (despite limitations in empirical research and changes in the market conditions) that future data is enough like past data to apply findings from such inferences to investment decisions.

“How should investors generate and interpret research findings in such an environment?”

To make room for Avoiding Investment Strategy Flame-outs on the CXOAdvisory.com main menu, we are retiring our “Investment Demons” (largely subsumed by the book). The demons will, however, remain available here.

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