Machine learning in finance
In recent years, machine learning techniques and big-data facilities have become quite popular in the finance and investment world. In the wake of this success, numerous machine learning researchers have decided to found their own asset management companies, hoping to capitalize on this trend.
This begs the question: Are large amounts of data and computing power all that is needed to tame the markets? In this article we delve into the uses and misuses of machine learning (ML) in finance.
The two kinds of machine learning
To the neophyte, all ML might look like the
Continue reading The Problem With Financial Oracles
Market prophets
We have all seen articles on financial news sites confidently predicting the future of various markets, often with remarkable specificity. Here are some that have appeared just in the past few weeks (as of 5 November 2018):
The stock market is setting up for another rally, according to Elliott Wave theory. Market strategist urges aggressive buying, says bull market could last decades. Short-seller who warned of ‘unavoidable pain’ earlier this year turns bullish. Stock strategist who saw market correction now predicts 10% to 14% rally — and a fizzle in 2019. Why the Dow Jones Industrial Average
Continue reading Profits, prophets and pseudoscience
It’s time for another look at the performance of hedge funds. Recent years have not been kind to hedge funds — not only has overall performance been less than stellar (particularly after fees), it has even lagged the S&P 500 index.
But what if we take a longer-term perspective? After all, the past eight years have been a bull market. What has happened in down markets?
A 28-year data comparison
One widely cited index for the hedge fund world is the HFRI Fund Weighted Composite Index (HFRI FWI), which is published by Hedge Fund Research, Inc. of Chicago. It includes
Continue reading Hedge fund performance report card
Prophets of doom
2018 has been another hard year for prophets of doom. Even though some markets have suffered minor corrections (and there are still four months to go!), in most cases broad-market indices in first-world nations are either up or not far from their levels in January. Here are some recent doomsday predictions (note that the author of the blog or article is not always the one making the prediction):
2015
[1 Mar 2015] Stock-market crash of 2016: The countdown begins [17 May 2015] Countdown to the stock-market Crash of 2016 is ticking louder [1 Jul 2015] Recession time
Continue reading Doomsayers and market prophets
Mutual fund performance
As we have noted in previous Mathematical Investor blogs (see this blog for instance), surprisingly few mutual funds beat their respective benchmark (typically some market index). Even fewer consistently beat their benchmark year after year.
A new report from S&P Dow Jones sheds light on this phenomenon. It tabulates, for each year from 2001 through 2017, the percentage of mutual funds in various categories that are out-performed by their respective benchmarks. Here is a brief summary of this performance data.
Table 1: Percentages of U.S. mutual funds beaten by their benchmark
Category Benchmark 2011 2012 2013 2014
Continue reading Mutual fund performance and survivorship bias
Target-date funds
“Target-date funds” are currently the rage in the finance world. The term refers to a mutual fund that targets a given retirement date, and then steadily shifts the allocation of assets from, say, a 80%/20% mix of stocks and bonds at the start to, say, a 30%/70% mix as the target date approaches.
Vanguard Group, which manages over USD$5 trillion in assets, much of it in employer-offered defined contribution retirement plans, reports that participation in its target date offerings have grown explosively in the past few years. In 2005, when Vanguard started offering target-date funds, only a few
Continue reading Are target-date funds the answer?
Is physics “lost in math”?
In a provocative new book, Lost in Math: How Beauty Leads Physics Astray, quantum physicist Sabine Hossenfelder argues that the scientific world in general, and the field of physics in particular, has repeatedly clung to notions that have been rejected by experimental evidence, or has pursued theories far beyond what can be tested by experimentation, mainly because these theories and the mathematics behind them were judged “too beautiful not to be true.” Examples cited by Hossenfelder include:
Supersymmetry. Supersymmetry, the notion that each particle has a “superpartner,” was originally proposed in the 1970s, and
Continue reading Are economics and finance “lost in math”?
Beware snake oil salesmen!
Economics
Bloomberg columnist Mohamed El-Erian recently lamented that the discipline of economics “is divorced from real-world relevance and has lost credibility.” Among the problems he mentions currently afflicting the field are the following:
The proliferation of simplifying assumptions that lead to an “overreliance on excessively abstract estimation techniques and approaches.” Insufficient consideration of the possibility that financial dislocations can disrupt the economy. Poor and grudging adoption of important insights from behavioral science and other disciplines. An oversimplification of uncertainty. An overemphasis of equilibrium conditions and mean reversion, and an underemphasis on structural changes and tipping
Continue reading Economics, finance and pseudoscience
In this post we look at the one plot that proves that technical analysis is useless.
Technical analysis and horoscopes
As volatility has returned in recent months, investors have sought advice from asset managers and other investment professionals. In many instances, such advice includes technical analysis (TA). Even many highly respected investment firms and financial news sources promote TA:
Charles Schwab represents TA as an indispensable tool for active traders (examples: here and here). Merrill Lynch offers a Market Analysis Technical Handbook. Some Bank of America / Merrill Lynch analysts utilize technical analysis: here. Fidelity considers TA an advanced technique
Continue reading The most important plot in finance
Introduction
Index investing has grown significantly over the past 30 years. Back in 1990, few were even aware of the option for indexing, and options were limited mostly to a handful of conventional mutual funds tracking the U.S. S&P 500 index. In 1993, Boston’s State Street Global Advisors launched the first S&P 500 index-tracking exchanged traded fund (ETF), with ticker SPY. Today this ETF controls over USD$300 billion in assets. Thousands of other index-tracking mutual funds and ETFs, tracking numerous different indices, in numerous different world markets and regions, are now in operation; in the U.S. alone, there were 1716
Continue reading Does indexing threaten the market?
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