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Big Ideas

These blog entries offer some big ideas of lasting value relevant for investing and trading.

A Few Notes from My Life as a Quant, Reflections on Physics and Finance

In his 2004 autobiography, My Life as a Quant, Reflections on Physics and Finance, Emanuel Derman recounts his experiences as a physicist driven by the forces of employment supply and demand to redirect his labor toward quantitative financial analysis/strategy. Knowledge and skills critical to his transition are: a sense of how the world works, modeling and programming. Much of the book is a straightforward recounting of activities, personalities and reactions, culminating in Mr. Derman’s derivatives modeling accomplishments. Toward the end of the book, he offers a few essential distillations, as follows: Keep Reading

Classic Research: Demography and the Stock Market

We have selected for retrospective review a few all-time “best selling” research papers of the past few years from the General Financial Markets category of the Social Science Research Network. Here we summarize the August 2002 paper entitled “Demography and the Long-Run Predictability of the Stock Market” by John Geanakoplos, Michael Magill and Martine Quinzii (download count over 4,400). In this paper, the authors link cyclic demographic behavior (borrowing when young, investing for retirement in middle age and disinvesting in retirement) with stock market price-earnings ratio (P/E) cycles. Using the overlapping generations model, they conclude that: Keep Reading

When Stock Market Models Crash

Didier Sornette has an interest in financial markets as examples of complex systems. He authored Why Stock Markets Crash : Critical Events in Complex Financial Systems, published in November 2002. He has maintained on his web site for several years a series of predictions regarding the behavior of the S&P 500 index. In initiating this series, he wrote:

“Based on a theory of cooperative herding and imitation working both in bullish as well as in bearish regimes that we have developed in a series of papers, we have detected the existence of a clear signature of herding in the decay of the US S&P 500 index since August 2000 with high statistical significance, in the form of strong log-periodic components.”

His September 2002 paper (with Wei Zhou) entitled “The US 2000-2002 Market Descent: How Much Longer and Deeper?” provides a detailed justification of this assertion, including a comparison of the 1990 Japanese and 2000 U.S. stock market crashes. The evolution of Professor Sornette’s predictions is as follows: Keep Reading

Fooled by Randomness: A Review

Nassim Taleb’s central theme in Fooled by Randomness (the 2004 second edition) is that noise generally swamps signal (true outperformance or underperformance) in financial markets, and in life generally. A standard deviation much larger than an associated average excess return, encountered consistently in the search for outperforming investing/trading strategies, is an indicator of such swamping. The book effectively uses corollaries and examples to reinforce Nassim Taleb’s contention that past performance is neither a guarantee of future returns nor a proof of either intelligence or stupidity. Rather than recount his arguments, we focus this review on his conclusions as they relate specifically to speculating in financial markets. These conclusions are: Keep Reading

Damodaran Online: Some Serious Education

Professor Aswath Damodaran of the Leonard Stern School of Business at New York University offers on his web site a broad and deep set of financial education materials covering: corporate finance, investment (portfolio) management and valuation. He presents considerable information from his books, such as Investment Philosophies and Investment Fables, including supporting data. For example… Keep Reading

The Adaptive Markets Hypothesis

In his March 2005 paper entitled “Reconciling Efficient Markets with Behavioral Finance: The Adaptive Markets Hypothesis”, Andrew Lo presents a framework for unifying the Efficient Markets Hypothesis (EMH) and Behavioral Finance. The paper is thoughtful and thought-provoking. Some key points are: Keep Reading

Focus Investment in Foreign Markets?

In The Anglosphere Challenge: Why the English-Speaking Nations Will Lead the Way in the Twenty-First Century, James Bennett implicitly advises focusing investments in certain countries. As depicted in the figure below, Mr. Bennett’s main thesis points are that: Keep Reading

Diversify, Diversify, Diversify(?)

In their February 2005 paper entitled “Portfolio Concentration and the Performance of Individual Investors,” Zoran Ivkovic, Clemens Sialm and Scott Weisbenner test the dictum for diversification by examining the stock trades of a large number of individuals during 1991-1996 through a discount broker. They find that: Keep Reading

Returns for Investors (Rather Than Markets)

In his June 2004 paper on “What Are Stock Investors’ Actual Historical Returns”, Ilia Dichev examines stock market capital inflows and outflows to determine how well investors really perform compared to buy-and-hold returns. He concludes that: Keep Reading

Triumph of the Optimists (Chapter-by-Chapter Review)

Triumph of the Optimists: 101 Years of Global Investment Returns by Dimson, Marsh and Staunton (2002) is thorough, logical and concise. With scores of illustrative graphs and figures, its statistics are accessible and its style straightforward. Its message, however, is somewhat at odds with the title. Below is a chapter-by-chapter review of the insights in this book: Keep Reading

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