Pulling Your Risk Estimates Up By Their Bootstrapped Simulations

London Business School’s Elroy Dimson, an emeritus finance professor, memorably defined risk as the possibility that more things can happen than will happen. Picking up on this description, the late, great institutional investment adviser Peter Bernstein once explained that Dimson’s view of risk points investors on a particular analytical path. “If more things can happen than will happen, we can devise probabilities of possible outcomes, but — and this is a big ‘but’ — we will never know in advance the true range of outcomes we may face.” Certainty, as always, is off limits when attempting to forecast the future….

Does Factor Timing Pass The Smell Test?

Academics and investment practitioners have long performed deep dives on momentum as a source of excess return premia. Analysis that focuses on value, small-cap and other accounting-based factors (book to market, capitalization, etc.) is a more recent addition to the research canon, but the seminal papers by Fama and French from the 1990s aren’t spring chickens either. In recent years a new line of inquiry that combines the two disciplines seeks to answer the question: Is timing of the standard risk factors based on momentum signals a worthy pursuit in its own right? A growing list of researchers are finding…

When Uncertainty Rises, Your Model Faces Higher Failure Risk

Prediction is difficult, Nils Bohr famously warned — especially about the future. The caveat needs no explanation in economics and finance, although a bit of clarification is required, starting with the obvious. If you spend more than 20 minutes studying the history of forecasting that routinely populates the world of macro and markets, it’s blazingly apparent that true sages are as common as hail storms in the Sahara. That’s a potent reason to steer clear of forecasts, right? Well, yes… sort of.  In reality, most investors don’t have the luxury to shun the prediction game entirely.  Investing and portfolio management,…

A Better Way To Model Bubble Risk

Supreme Court Justice Potter Stewart famously punted when trying to define pornography, although he wryly admitted that “I know it when I see it.” The same might be said of financial bubbles. When The New Yorker asked Eugene Fama, a founding father of indexing, to comment on the so-called credit bubble that preceded the 2008 financial crisis, he refused to take the bait. “I don’t even know what a bubble means,” he said. “These words have become popular. I don’t think they have any meaning.” Perhaps, but that doesn’t stop anyone from trying to identify the danger signs in advance…

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