30

I can only talk about quantitative trading. As a rule of thumb, the lower frequency you work in, the more econometrics is important, whereas for a higher frequency, the more econometrics becomes useless. (I would still recommend a top econometrician for HFT since they have what it takes to succeed, it's just the models aren't out-of-the-box applicable.) But ...


11

I'm not sure about the "CAPM formula" that you are referring to. I assume you are referring to the estimated coefficient of a regression of a security on a market portfolio. That is to say \begin{equation} \beta_{security,market} = \frac{\sigma_{security,market}}{\sigma^2_{market}} \end{equation} The idiosyncratic risk is the portion of risk unexplained ...


10

I found this paper: Conditional value-at-risk for general loss distributions by Rockafellar and Uraysev http://dx.doi.org/10.1016/S0378-4266(02)00271-6 which says CVaR is coherent for general loss distributions, including discrete distributions. I think that I was confused by other authors who were also confused with the definitions of CVaR. In particular, ...


10

Upon close reading, this appears to be 3 (interesting) questions, not one. I'm not sure if the mods have the tools needed to split it up, so I'm just going to write down the three questions as I see them and then deal with them one by one. Note, it is simpler for me to talk about variance instead of volatility. This has no material impact on the answer. ...


9

I would use the identity and three step process that: $$\textrm{Total Variance} = \textrm{Systematic Variance} + \textrm{Unsystematic Variance}$$ You can calculate systematic variance via: $$\textrm{Systematic Risk} = \beta \cdot \sigma_\textrm{market} \Rightarrow \; \textrm{Systematic Variance} = (\textrm{Systematic Risk})^2$$ then you can rearrange ...


8

$VaR^\alpha$ is not a coherent risk measure because it fails sub-additivity (a coherent risk measure is monotonic, sub-additive, positive homogenous, and translation invariant). The expectation operator $E[\cdot]$ is linear, so it meets sub-additivity, as well as the other three properties, so $CVaR$ is a coherent risk measure.


7

Great question. We would expect 3rd party risk providers to have specialized expertise (robust regression techniques, factor research, data cleansing etc.). We might grant them these advantages but still find weakness in the product design. Let's start off with the different uses of risk models and the procedure or metric which is maximized to solve for ...


7

One relevant paper is: Shenoy, C. and Shenoy, P.P., Bayesian network models of portfolio risk and return, 1999. PDF


7

Step 1: Get your data from SQL into R -> http://www.r-bloggers.com/?s=SQL Step 2: Run your analysis/optimizations like -> http://www.r-bloggers.com/portfolio-optimization-in-r-part-1/ or http://blog.streeteye.com/blog/2012/01/portfolio-optimization-and-efficient-frontiers-in-r/ or via RMetrics: http://www.statistik.wiso.uni-erlangen.de/lehre/bachelor/...


7

@user2763361 has a very thorough list of useful econometric topics for quantitative finance. I would add missing, mixed frequency, and irregular data as major issues that I'm either constantly dealing with or begrudgingly ignoring. Seasonal adjustment is important too for some data (like electricity futures), though the subject is also related to his ...


6

Also, RiskMetrics' 'granular approach' may be of interest (I have no affiliation): See: I. Developing an Equity Factor Model for Risk II. The RiskMetrics 2006 Methodology, RM2006


6

Conditional VaR (CVaR), which is also called Expected Shortfall, is a coherent risk measure (although being derived from a non-coherent one, namely VaR). See this paper: Expected Shortfall: a natural coherent alternative to Value at Risk from Carlo Acerbi and Dirk Tasche http://www.bis.org/bcbs/ca/acertasc.pdf EDIT: I just saw that you emphasized ...


6

I know you're really looking for some empirical work on this topic, but I think the following theoretical paper puts your question into proper perspective.* Risk-Based Asset Allocation: A New Answer to an Old Question by Wai Lee, JPM 2011. Overall, he finds that supposedly risk-based approaches to portfolio construction are really making implicit ...


6

Risk-free rate is that you get for letting someone else use your money in a riskless manner. Suppose we live in a world where there is no risk whatsoever. In particular, if you lend someone \$100 there is 100% certainty that he will pay you back in a year. Before the pay date, he can do whatever he wants with your $100, while you have no access to it. Even ...


5

Danielsson and Macrae suggest that portfolio optimization should be based on simple models. I interpret that to mean using something like Ledoit-Wolf (as opposed to most commercial models). In that case doing it yourself is not at all laborious assuming you have return data. A link to Danielsson and Macrae (worth reading if you haven't seen it) is in http:...


5

There are a lot of code in Eric Zivots recent class in computational finance. http://spark-public.s3.amazonaws.com/compfinance/R%20code/portfolio.r http://spark-public.s3.amazonaws.com/compfinance/R%20code/testport.r http://spark-public.s3.amazonaws.com/compfinance/R%20code/rollingPortfolios.r Also, you can google some slides in his class where he ...


5

Autocorrelation of returns can be used as a proxy measure for liquidity of the asset. The degree of serial correlation in an asset’s returns can be viewed as a proxy for the magnitude of the frictions, and illiquidity is one of the most common forms of such frictions. A strongly liquid asset should reveal no serial autocorrelation. You can perhaps build ...


5

I think what you are missing is simply the Vega-Gamma relation in the Black-Scholes model. Namely: $$ Vega = \frac{\partial v}{\partial \sigma} = \sigma(T-t)S^2 \frac{\partial^2 v}{\partial S^2} = \sigma \tau S^2 \Gamma $$ Plugging this into your coverage error, you get its expression in terms of the Vega which is the most natural measurement of your ...


4

A simple top-down shortcut calculation : Set annualized alpha = compounded alpha = 1 + a1 + a2 + a1*a2 + ... = $\Pi$ (1 + $\alpha_t$) Set annualized return from factors = compounded factor return = $\Pi$ (1 + $factorReturn_t$) Interaction Term contribution is then = Compounded Security Return - Compounded alpha - Compounded factor return Therfore the ...


4

I tested both procedures. The results are virtually indistinguishable - the decision is not consequential. I opted for approach #1.


4

Book: Counterparty Credit Risk: The new challenge for global financial markets by Jon Gregory


4

Barrie and Hibbert might provide some help - they have a reputation based on understanding insurance risks http://www.barrhibb.com/research_and_insights


4

Most of the credit risk models are some derivative of survival models. Cox Proportional Hazard is one of the early and more popular models, Kaplan-Meier and Logrank tests are others you may have heard of. There are a few ways to go from here. The simplest is to model the sample as binomial with one population as current and the other as in default. A ...


4

No specific history. I'm not aware who introduced this measure initially. Most probably it came up as an example in the research papers on coherent risk measure. All names make sense to some extent: Expected shortfall - as it's an expectation of losses Conditional Value at Risk - as it can be written as $E[X |X >VaR_α(X)]$, i.e. conditional expectation ...


4

First, I am quite sure that this is a typo and it should be $$ 0 < VaR_1 < VaR_0 $$ then $$ -VaR_0 < -VaR_1 $$ and the plot is correct. Second, the put strategy does not change only the expected profit but the whole distribution of the P&L. If you buy a put with strike $K_1 = -VaR_1$ then you get compensated for losses below $K_1$. But you ...


4

Firstly, the use of the logit models to estimate the PDs is particularly appreciated in some credit industries, as, for instance, the credit retail one. The logit model predicts pretty well the PD on loans, consumer credit, credit cards, ... and all concerns the retail consumer world. Mainly, those listed are the principal sub-industries in the credit ...


4

Let the $n-$dimensional vector of returns $\mathbf{r}$ have a multivariate t distribution with $\nu$ degrees of freedom. The marginal distribution of any component $r_i$ has a univariate t distribution also with $\nu$ degrees of freedom. To see this, assuming mean returns have been subtracted, the multivariate t distribution decomposes as the distribution ...


3

If Y is the excess returns of your asset and X is that of the market, then CAPM tells you $Y = \beta X + \epsilon$ Taking the variance of both sides yields $$ \\ \sigma^2_{Y} = \beta^2 \sigma^2_{X} + \sigma^2_{\epsilon} \\ $$ We know that $$\beta = \frac{\sigma_{X,Y}}{\sigma^2_{X}} = \rho_{X,Y}\frac{\sigma_{Y}}{\sigma_{X}}$$ Where $\sigma_{X,Y}$ is the ...


3

do a regression where stock returns is dependent and market return is independent variable. Value of R^2 is Systematic risk and value of 1-R^2 is unsystematic risk...


3

First you need to define what you need a risk measure for. It is usually to take a decision, so you have an operational criterion that defines your risk. You should go back at this point and see what is the impact of a change of distribution on it. Just say for instance that you need a risk measure to take decisions according to a Sharpe ratio and define it ...


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