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Aug 3

Few Interesting Papers to Read

Posted by abiao at 12:23 | Others | Comments(1) | Reads(6866)
My blog was down last few days due to a technical problem of server, sorry for that. A few interesting papers I have read recently and like to share with you.

Market Timing with Option-Implied Distributions: A Forward-Looking Approach http://w4.stern.nyu.edu/emplibrary/Market%20timing%20with%20Option%20implied%20distributions_Feb_2011.pdf
We address the empirical implementation of the static asset allocation problem by developing a forwardlooking approach that uses information from market option prices. To this end, we extract constant maturity S&P 500 implied distributions and transform them to the corresponding risk-adjusted ones. Then we form optimal portfolios consisting of a risky and a risk-free asset and evaluate their out-of-sample performance. We find that the use of risk-adjusted implied distributions times the market and makes the investor better off than if she uses historical returns’ distributions to calculate her optimal strategy. The results hold under a number of evaluation metrics and utility functions and carry through even when transaction costs are taken into account.
Not surprisingly, the reported market timing ability deteriorated during the recent subprime crisis. An extension of the approach to a dynamic asset allocation setting is also presented.

Principal Components as a Measure of Systemic Risk http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1582687
The U.S. government’s failure to provide oversight and prudent regulation of the financial markets, together with excessive risk taking by some financial institutions, pushed the world financial system to the brink of systemic failure in 2008. As a consequence of this near catastrophe, both regulators and investors have become keenly interested in developing tools for monitoring systemic risk. But this is easier said than done. Securitization, private transacting, and “flexible” accounting prevent us from directly observing the many explicit linkages of financial institutions. As an alternative, we introduce a measure of implied systemic risk called the absorption ratio, which equals the fraction of the total variance of a set of asset returns explained or “absorbed” by a fixed number of eigenvectors. The absorption ratio captures the extent to which markets are unified or tightly coupled. When markets are tightly coupled, they become more fragile in the sense that negative shocks propagate more quickly and broadly than when markets are loosely linked.

How does the Fortune's Formula-Kelly capital growth model perform? http://www.efmaefm.org/0EFMAMEETINGS/EFMA%20ANNUAL%20MEETINGS/2011-Braga/papers/0103.pdf
William Poundstone's (2005) book, Fortune's Formula, brought the Kelly capital growth criterion to the attention of investors. But how do full Kelly and fractional Kelly strategies that blend with cash actually preform in practice? To investigate this we revisit three simple investment situations and simulate the behavior of these strategies over medium term horizons using a large number of scenarios.

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