Richard Herron
  • Member for 10 years, 11 months
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How does the "risk-neutral pricing framework" work?
34 votes

We bet on a fair coin toss -- heads you get $\$100$, tails you get $\$0$. So the expected value is $\$50$. But it is unlikely that you'll pay $\$50$ to play this game because most people are risk ...

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Has high frequency trading (HFT) been a net benefit or cost to society?
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23 votes

The lead paper in the January 2011 Journal of Finance (Hendershott, Jones, and Menkveld) addresses algorithmic trading (AT). In short, they find that AT improves liquidity as measured by bid-offer ...

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Why are GARCH models used to forecast volatility if residuals are often correlated?
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15 votes

One of the reasons the ARCH family of models is used is that you only need price data to generate the model. These data exist back to the 1800s, so ARCH is great for looking at volatility over very ...

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Control for bid/ask bounce in high-frequency trade data?
14 votes

IMO transaction data is a better approach, because you have both sides of the trade agreeing that the price is "right." The literature tends to decompose the transaction price $P$ into a true/...

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Why is there no "meta-model"?
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14 votes

There are plenty of market models -- capital asset pricing model (CAPM), conditional CAPM (CCAPM), intertemporal CAPM (ICAPM), and arbitrage pricing theory (APT). But any model, finance or otherwise, ...

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What type of analysis is appropriate for assessing the performance time-series forecasts?
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14 votes

I think you're looking for some way to test for autocorrelation in your residuals. If your model is good -- let's say you have an ARMA(1, 1) model for your forecast -- then the residuals from this ...

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What is the "delta" option quoting convention about?
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14 votes

Delta is the partial derivative of the value of the option with respect to the value of the underlying asset. An option with a delta of 0.5 (here listed as +50 points) goes up \$0.50 if the underlying ...

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Is there any theoretical basis for pattern-recognition strategies?
13 votes

Weak form market efficiency says that you can't predict prices based on past prices. Or that technical analysis doesn't work. I think that the tests of weak form market efficiency are pretty ...

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data on historical stock price of bankrupt companies
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12 votes

Google and Yahoo finance have a survivorship bias -- they only include firms that are still around. I know of no free source that provides the data you seek. I get my data from Compustat and CRSP via ...

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Using linear regression on (lagged) returns of one stock to predict returns of another
11 votes

A few thoughts. Yes, your return series are autocorrelated (i.e., stocks don't exactly follow a random walk), so you should use Newey-West standard errors. If you do this as a univariate regression $...

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How do I reproduce the cross-sectional regression in "Intraday Patterns in the Cross-section of Stock Returns"?
11 votes

The $R^2$s are usually close to zero for single stock regressions. The big $R^2$s that a lot of asset pricing research shows is by forming portfolios. Forming portfolios cancels a lot of the ...

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How to perform risk factor calculation?
10 votes

I don't have much to add, but wanted to address the "price of risk" question. APT is kind of "economics"-free and tries to price assets without the utility maximization required in CAPM/ICAPM. Ross's ...

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What is the unit of the Distance to Default measure?
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10 votes

Distance to default $DD$ should be measured in standard deviations. You convert this into a probability $p_{default}$ using the normal CDF: $p_{default} = N(-DD)$. So if $DD = 2.978$ then the firm is ...

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Deterministic interpretation of stochastic differential equation
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10 votes

(1) You analytically solve a stochastic differential equation (SDE) using Ito's lemma. Your second equation (the discretized one) is how you could model one path over one step. To find the solution, ...

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Is Conditional Value-at-Risk (CVaR) coherent?
9 votes

$VaR^\alpha$ 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 ...

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Are two identical time series cointegrated?
9 votes

Let us test that $x$ and $y$ are co-integrated, say that $x_t, y_t \sim I(1)$. In the Engle-Granger we test stationarity of the error term in $$y_t = \alpha + \beta x_t + u_t$$ which we estimate as $$\...

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Using Black-Scholes equations to "buy" stocks
9 votes

You can look at equity as a call option on the firm. In theory this illustrates the differences between holding equity or debt. The quick and dirty is that equity holders own the firm, but only ...

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What concepts are the most dangerous ones in quantitative finance work?
7 votes

That value stocks are necessarily riskier than growth; that there has to be a hidden risk factor that we haven't yet found. The Lakonishok, Shleifer, and Vishny abstract says it better than I can: ...

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What are the popular methodologies to minimize data snooping?
7 votes

The output of your model will be a realization of your assumptions. Shane's given you a great answer. Besides doing out of sample testing (i.e., calibrating on period X then testing in period Y only ...

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Why does the VIX index have *any* correlation to the market?
7 votes

VIX is mechanically determined from the price of S&P500 call and put options. So if the demands for S&P500 calls/puts rise, then the prices rise, then the implied vol from these options rises. ...

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Given two portfolios with identical correlation matrices, which one will have a better risk/reward ratio?
6 votes

From a theoretical point of view (you mentioned beta, so assume we're in a CAPM world), you should hold the market portfolio (let's assume S&P500 index) and be long (or short) the risk-free asset ...

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Can the futures market's open interest predict commodity, treasury, and equity returns?
6 votes

Maybe a better question title is "Can futures market open interest predict commodity, treasury, and equity returns"? I saw this paper in an earlier form and it still baffles me. Superficially, it ...

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Predicting Price Movements on a Betting Exchange
6 votes

Have you looked into "noise trader" models? This seems like a market that is mostly noise. A few betters may have some information on or real knowledge of who might win, but certainly nothing like ...

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Do low volatility stocks outperform high volatility stocks over the long run?
6 votes

The theory predicts that expected risk and expected return should be positively related. But no one has convincingly proved this. The results are very sensitive to how you determine the expectations ...

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Who has introduced the term 'vega' and why?
6 votes

I have no reference, but it's largely phonetic. Must variables in econ/finance are Greek versions English letter you'd want to use. $\omega$ for weight, $\rho$ for rate, $\epsilon$ for error, and so. ...

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Garch modelling on Stata
5 votes

I don't use Stata often, but the help() function is typically very good. Try help(garch). It looks like the command is garch _depvar_ _indepvars_ _options_ Here's the help page on the web.

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Debunking risk premium via "hedging" argument? (or why even in the real world $\mu$ should equal $r$)
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5 votes

If you're long the underlying and short the futures contract, then you have no risk and earn the risk-free rate. You get into the position at $S_0$ and will be able to get out of the position at $F_0$ ...

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Mean reverting Indicator
5 votes

I think of mean reversion as more of a single stock phenomenon. In aggregate, these ididosyncratic mean reversions should offset one another and make the market smoother than its component stocks. ...

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How would one price a "credit event binary option"?
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5 votes

I would see if a binomial tree gives reasonable answers (i.e., can you get close to the CEBOs with high volume). You could determine the probability of default over a given interval using the KMV-...

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Supply and Demand of Oil
5 votes

This occurs because the price elasticity of demand for oil is near zero, which is to say the demand curve is nearly vertical. This is partly a limited rate of production story (i.e., in the short term ...

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