Quant Mashup - Capital Spectator Research Review | 26 August 2016 | The Business Cycle [Capital Spectator]Do Stock Market Trading Activities Forecast Recessions? Ujjal Chatterjee (University of Wisconsin-Milwaukee, American University of Sharjah) August 9, 2016 This paper re-examines the existing recession forecasting models with stock market liquidity as an additional forecasting variable. We(...) 50 Years Of Sharpe Ratio Analysis: Useful But Easily Abused [Capital Spectator]The Sharpe ratio was introduced half a century ago and it’s still going strong. Although the world is now awash with competitors, the granddaddy of quantitative risk metrics endures. Its longevity and widespread use drives some analysts batty, but for good or ill the SR is deeply embedded into the(...) Research Review | 15 July 2016 | Portfolio Analysis [Capital Spectator]Asset Allocation: A Recommendation for Resolving the Collision between Theory and Practice Larry J. Prather (Southeastern Oklahoma State University), et al. April 26, 2016 We examine the creation of a low-cost optimal risky portfolio that individual investors can easily construct and manage. We(...) Bogle Says Indexing Destined To Win The Battle Of The Quants [Capital Spectator]Vanguard founder John Bogle gave a powerful speech last month at the Q Group’s Spring Seminar that lays out the case (again) for favoring basic indexing and shunning complexity in matters of portfolio design and management. As Morningstar’s John Rekenthaler points out, Bogle wields the weapon of(...) Research Review | 22 Apr 2016 | Risk Analysis [Capital Spectator]The Market Portfolio is NOT Efficient: Evidences, Consequences and Easy to Avoid Errors Pablo Fernandez (University of Navarra), et al. March 16, 2016 The Market Portfolio is not an efficient portfolio. There are many evidences that tell us that: the equal weighted indexes have beaten their(...) A Better Way To Run Bootstrap Return Tests: Block Resampling [Capital Spectator]Developing confidence about a portfolio strategy’s track record (or throwing it onto the garbage heap), whether it’s your own design or a third party’s model, is a tricky but essential chore. There’s no single solution, but a critical piece of the analysis for estimating return and risk,(...) Testing Asset Allocation Results With Random Market Selection [Capital Spectator]Skill is a slippery concept in finance, courtesy of the shady influence of chance in asset pricing. It's also an awkward topic in just about every corner of money management because discussing it in detail invariably raises serious doubts about our ability to engineer investment results that(...) The Dynamic Duo Of Risk Factors: Part II [Capital Spectator]Last week’s post on analyzing US equity value and momentum risk premia ended with a question: How much, if any, improvement should we expect by adding a dynamic system for managing exposure to these risk factors vs. a buy-and-hold strategy? What follows is a preliminary effort in searching for an(...) The Dynamic Duo Of Risk Factors: Part I [Capital Spectator]The value and momentum factors have earned high praise in recent years as complementary sources of risk premia for designing and managing equity portfolios. AQR’s widely cited paper “Value and Momentum Everywhere” a few years back helped popularize the idea, pointing to applications in(...) Research Review | 11 Mar 2016 | Portfolio Strategy [Capital Spectator]Understanding Modern Portfolio Construction Cullen O. Roche (Orcam Financial Group) February 22, 2016 Over the last 75 years there have been great strides in modern finance, portfolio theory and asset allocation strategies. Despite this progress the process of portfolio construction remains grounded(...) Estimating Return-Shortfall Risk For Portfolios [Capital Spectator]Failure isn’t an option, but it happens. Modeling the possibility that a portfolio strategy will stumble isn’t exactly cheery work, but it’s a productive and necessary exercise for stress testing what the future can do to the best-laid plans for investing. The good news is that there’s a(...) Tactical Asset Allocation For The Real World [Capital Spectator]Managing risk via tactical asset allocation (TAA) offers a number of encouraging paths for limiting the hefty drawdowns that take a toll on buy-and-hold strategies. But what looks good on paper can get ugly in the real world. There's a relatively easy fix, of course: consider the total number(...) Modeling “What If?” Scenarios With Impulse Response Simulations [Capital Spectator]Analyzing history as a guide to the future is riddled with caveats, but if you’re mindful of the limitations there’s a mother lode of perspective waiting to be mined in the cause of modeling relationships in macro and markets. One of the more useful techniques in this corner: impulse-response(...) Portfolio Analysis in R: Part VI | Risk-Contribution Analysis [Capital Spectator]Do you know where the risk in your portfolio is coming from? Well, of course, you do. After all, you designed the portfolio and so the asset weights reflect the risk contribution. A 50% weighting in stocks translates into a 50% contribution to risk for the portfolio overall, right? That’s a(...) Portfolio Analysis in R: Part V | Risk Analysis Via Factors [Capital Spectator]In the previous installment in this series of analyzing a globally diversified portfolio we reviewed the results after adding a momentum-based risk-management system. The test suggested that a tactical overlay can be productive… maybe, depending on the details. Let’s continue to investigate our(...) A (Partial) Solution For Narrative Risk: Probit Modeling [Capital Spectator]The search for objective analysis in the cause of making informed investment decisions is the Holy Grail of finance. Unfortunately, narrative risk continually threatens to derail us on our crucial quest for perspective. Everyone loves a good story, and it’s no different when it comes to finance(...) Research Review | 11 2015 Dec | Portfolio Management [Capital Spectator]Buffett’s Asset Allocation Advice: Take it … With a Twist Javier Estrada October 26, 2015 One of the most important decisions retirees need to make is the asset allocation of their portfolios. They can have a static or a dynamic allocation, and simplicity usually favors the former. Warren(...) Is The Acceleration Factor A Better Way To Measure Momentum? [Capital Spectator]Momentum has received a lot of attention in the asset-pricing literature over the past several decades, and for good reason. Trending behavior is a staple in markets. In contrast with other pricing “anomalies”, short-term return persistence—positive and negative—is a robust factor across(...) Value+Momentum+Asset Allocation=A Powerful Strategy [Capital Spectator]In a new article from Institutional Investor—“Market Timing Is Back In The Hunt For Investors”–AQR Capital Management reviews the case for market timing and finds an encouraging track record. Citing the historical record from 1900, AQR’s Cliff Asness and two colleagues outline what is(...) 3 Common Backtesting Traps With Easy Solutions [Capital Spectator]Backtests have become the weapon of choice for rationalizing various forms of tactical asset allocation, which has become increasingly popular as a risk-management tool since the 2008 crash. The hazards of backtesting—studying how a strategy performed in the past–are well known, which leads some(...) Research Review | 6 Oct 2015 | Portfolio Risk Management [Capital Spectator]How Do Investors Measure Risk? Jonathan Berk and Jules H. Van Binsbergen October 1, 2015 We infer which risk model investors use by looking at their capital allocation decisions. We find that investors adjust for risk using the beta of the Capital Asset Pricing Model (CAPM). Extensions to the CAPM(...) Using Random Portfolios To Test Asset Allocation Strategies [Capital Spectator]Last month I tested random rebalancing strategies based on dates and found that searching for optimal points through time to reset asset allocation may not be terribly productive after all. Let’s continue to probe this line of analysis by reviewing the results of randomly changing asset weights(...) Skewed By Randomness: Testing Arbitrary Rebalancing Dates [Capital Spectator]How much influence do investors have over their portfolios? Perhaps it's less than commonly assumed. The notion that randomness plays a role in money management has been widely studied in finance-Nassim Taleb's popular treatment in Fooled by Randomness: The Hidden Role of Chance in Life(...) Research Review | 13 Aug 2015 | Portfolio Management [Capital Spectator]Research Review | 13 Aug 2015 | Portfolio Management Momentum and Markowitz: A Golden Combination Wouter J. Keller, Adam Butler, and Ilya Kipnis May 16, 2015 Mean-Variance Optimization (MVO) as introduced by Markowitz (1952) is often presented as an elegant but impractical theory. MVO is “an(...) Reviewing Small-Cap & Value Premiums Through An ETF Lens [Capital Spectator]In theory, small-cap and value stocks offer solid premiums over their large-cap and growth counterparts. In the short term, however, turning theory into real-world profits can get messy. As an example, let's review how the small-cap and value premia stack up at the moment via representative(...) Tail-Risk Analysis In R: Part I [Capital Spectator]It’s hard to overestimate the importance of modeling tail risk when it comes to the care and feeding of investment portfolios. But where to begin? The topic of studying, estimating and otherwise dissecting rare but extreme market events can be a black hole of analytical possibilities and(...) Efficient Frontier Portfolios – Impractical But Still Useful [Capital Spectator]The concept of building “optimal” portfolios—maximizing return and minimizing risk–is a foundational concept in quantitative finance. Unfortunately, it’s not terribly practical. The problem, as many researchers have demonstrated over the years, is the elusive aspect of developing reliable(...) Backtesting With Synthetic and Resampled Market Histories [Capital Spectator]We’re all backtesters in some degree, but not all backtested strategies are created equal. One of the more common (and dangerous) mistakes is 1) backtesting a strategy based on the historical record; 2) documenting an encouraging performance record; and 3) assuming that you’re done. Rigorous(...) Estimating Crash-Risk Potential For The US Stock Market [Capital Spectator]History shows rather clearly that the stock market is prone to extreme events, aka crashes. The challenge is deciding when the risk for a repeat performance is unusually high. The literature offers endless possibilities, which is a reminder that the market can crumble for any number of reasons. The(...) Modeling "Safe" Spending Rates For Retirement Portfolios [Capital Spectator]Deaccumulation is the new new thing in finance for an obvious reason: the US population is aging, which means that retirement becomes an increasingly pressing issue for financial planning. Perhaps the leading challenge for this critical task (other than accumulating a sufficient pot of money) is(...) Looking For Alpha Usually Leads Back To Beta [Capital Spectator]Every time someone comes up with a “new and improved” way to invest or predict which active managers will shine, it seems that subsequent research finds that it’s really just about focusing on different betas. The latest example is a new study (“Deactivating Active Share”) from AQR, a(...) Does Smart Beta = Smart Asset Allocation? [Capital Spectator]Most of the glowing analysis of so-called smart beta ETFs focuses on individual funds and how they offer advantages over their conventionally designed counterparts that weight securities by market capitalization—classic beta, as we’ll call them here. But what happens when we design portfolios(...) Research Review | 20 Mar 2015 | Tactical Asset Allocation [Capital Spectator]How Often Should You Take Tactical Asset Allocation Decisions? Byeong-Je An, et al. March 5, 2015 About once a quarter. We compute optimal tactical asset allocation (TAA) policies over equities and bonds when both asset returns are predictable. By varying how often the weights are reset, we estimate(...) Portfolio Analysis in R: Part IV | Enhancing A Global Strategy [Capital Spectator]In the previous post on using R for portfolio analysis and design, we discovered that global diversification across asset classes has been modestly beneficial relative to a basic 60%/40% US stock/bond allocation. The global aspect didn’t add a lot of value because US equities during the sample(...) We’re All Backtesters Now [Capital Spectator]A recent paper (“Evaluating Trading Strategies”) on the hazards of backtesting in The Journal of Portfolio Management has been receiving a fair amount of attention lately, inspiring some folks to go off the deep end and argue that econometric analysis of investment strategies is always a bad(...) Portfolio Analysis in R: Part III | Adding A Global Strategy [Capital Spectator]I’ve been analyzing a 60/40 US stock/bond portfolio in R in a series of posts and today’s installment picks up from the previous post by adding a global strategy. The goal is enhancing the 60/40’s return while keeping risk at a comparable if not lesser level. Overly ambitious? Perhaps, but(...) Portfolio Analysis in R: Part II | Analyzing A 60/40 Strategy [Capital Spectator]In a previous post I reviewed the basics of using the PerformanceAnalytics package in R for evaluating a simple 60/40 US stock/bond portfolio based on a pair of ETFs. Let’s round out that preliminary review by exploring a few additional applications before moving on to a deeper level of analysis(...) A Revelation For Small-Cap Investing Strategies [Capital Spectator]Suddenly business as usual for small-cap investing is in need of a makeover, thanks to a new research paper (a landmark study for asset pricing) that revisits, reinterprets and ultimately revives the case for owning these shares — after controlling for quality, i.e., “junk”. Cliff Asness of(...) A Momentum-Based Trading Signal With Strategic Value [Capital Spectator]Traders and investors tend to operate in parallel universes, using different analytical toolkits and looking at markets from radically different perspectives. But sometimes there’s common ground. David Varadi’s recent investigation of what he calls error-adjusted momentum (EAM) to normalize(...) The Long-Suffering “Average” Investor [Capital Spectator]Earning a respectable investment is hard. Holding it on to it is even harder, according to a variety of studies over the years that have analyzed the portfolios that investor build and own. The news is at once disturbing and baffling. Disturbing because a large population of individuals have earned(...) The Rise Of Factor Investing And The Implications For Asset Allocation [Capital Spectator]Once upon a time there was only one factor—the market, a la the capital asset pricing model. But after a half century of crunching the numbers since CAPM was born, “now we have a zoo of new factors,” as Professor John Cochrane observed a few years ago. In theory, identifying more factors opens(...) Portfolio Analysis in R | A 60/40 US Stock/Bond Portfolio [Capital Spectator]How’s that rebalancing strategy working out for ‘ya? Results will vary, of course, depending on when we run the analysis, the architecture of the strategy, and a number of other variables. Deciding if the results are satisfying or disappointing could be due to any number of factors, such as the(...)