Sunday, December 31, 2017

Most Important Investment Lessons of 2017

On this last day of 2017, we are going to list some of the most important lessons of the year.

In May, Paul Singer of Elliott Management laid out some of his major investment lessons in his letter to investors. In our opinion, the followings are the most important:

  • No security price is too high (or low) that it cannot go higher (or lower)
  • Turns in markets are impossible to time
  • Big changes in market prices frequently occur far in advance of when the reasons for the changes become apparent, and by then it is too late to incorporate the new information into one’s trading at the old prices Read more

Click here to watch Paul Singer’s Strategy for Successful Investing

Elliott Management Founder and Co-CEO Paul Singer discusses his investment technique as trying to “make money as close as possible to all the time.” He also talks about why his strategy for holding Argentina bonds paid off so well. He speaks to David Rubenstein on “The David Rubenstein Show: Peer-to-Peer Conversations.”

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Friday, December 29, 2017

Mean Reverting and Trending Properties of SPX and VIX

In the previous post, we looked at some statistical properties of the empirical distributions of spot SPX and VIX. In this post, we are going to investigate the mean reverting and trending properties of these indices. To do so, we are going to calculate their Hurst exponents.

There exist a variety of techniques for calculating the Hurst exponent, see e.g. the Wikipedia page. We prefer the method presented in reference [1] as it could be related to the variance of a Weiner process which plays an important role in the options pricing theory. When H=0.5, the underlying is said to be following a random walk (GBM) process. When H<0.5, the underlying is considered mean reverting, and when H>0.5 it is considered trending.

Table below presents the Hurst exponents for SPX, VIX and VXX. The data used for SPX and VIX is the same as in the previous post. The data for VXX is from Feb 2009 to the present. We display Hurst exponents for 2 different ranges of lags: short term (5-20 days) and long term (200-250 days).

Lag (days) SPX VIX VXX
5-20 0.45 0.37 0.46
200-250 0.51 0.28 0.46

We observe that SPX is mean reverting in a short term (average H=0.45) while trending in a long term (average H=0.51). This is consistent with our experience.

The result for spot VIX (non tradable) is interesting. It’s mean reverting in a short term (H=0.37) and strongly mean reverting in a long term (H=0.28).

As for VXX, the result is a little bit surprising. We had thought that VXX should exhibit some trendiness in a certain timeframe.  However, VXX is mean reverting in both short- and long-term timeframes (H=0.46).

Knowing whether the underlying is mean reverting or trending can improve the efficiency of the hedging process.


[1] T. Di Matteo et al. Physica A 324 (2003) 183-188

Post Source Here: Mean Reverting and Trending Properties of SPX and VIX

Friday, December 22, 2017

Liquidity Risk and Exchange Traded Funds

The sell-off in the high yield bond Exchange Traded Funds space last month reminds us of an important risk factor: liquidity.

But what exactly is liquidity risk? According to Aleksander Kocic, derivatives strategist at Deutsche Bank AG,

Liquidity transforms the risk of default (the ability that the debtor may not be able to pay back his debt) into the risk that the securities representing the debt find no purchasers ... today’s era of booming bond sales has an eerie parallel to the subprime crisis of the mid-2000s. Back then, low interest rates spurred an intense search for yield that culminated in investors purchasing risky home loans in the form of securitized and salable bonds. Such securitizations had the benefit of convenience as investors could buy and sell specific exposures comprising hundreds of thousands of individual home loans.

The forced unwind of leverage was responsible for the transformation of conditional insolvency to unconditional illiquidity. Read more

[caption id="attachment_436" align="aligncenter" width="561"]High Yield Bond exchange traded fund HYG High Yield Bond ETF as at Dec 22, 2017. Source: Interactivebrokers[/caption]

With the recent proliferation of Exchange Traded Funds, there is no surprise that there exist ETFs that are supposedly designed to offer “liquidity transformation”, i.e. they would allow investors to buy and sell illiquid debt instantaneously. However, liquidity risk is still there, and those ETFs can actually exacerbate the risk.

As for now, an important question to ask is: was the liquidity risk priced in? According to John Davi on Valuewalk, it is not, and 2018 can see an increase in liquidity risk.

The markets, however, trade on the margin and 2018 will begin to see liquidity decline in the US. The Fed has started to raise rates, wants to hike more, and quantitative tightening will further reduce liquidity.  The repercussions are quite significant – especially on the margin.

It is not surprising that liquidity sensitive asset classes such as US high yield credit, US Small Caps, and Japan corrected in October/November. Historically, liquidity in capital markets starts to decline in Q4 as banks begin to wind down their balance sheet ahead of year end.  Plus, we have the potential for another Fed rate hike in December.  The “liquidity based correction” was likely in anticipation of both events. Read more

If liquidity deteriorates, portfolio managers can use liquid credit and/or volatility derivatives to hedge the risks.

Originally Published Here: Liquidity Risk and Exchange Traded Funds

Saturday, December 2, 2017

Interview with Robert Shiller, 2017 Truman Medal Recipient

Robert James Shiller  is an American Nobel Laureate, economist, academic, and best-selling author. He currently serves as a Sterling Professor of Economics at Yale University and is a fellow at the Yale School of Management's International Center for Finance. Shiller has been a research associate of the National Bureau of Economic Research (NBER) since 1980, was vice president of the American Economic Association in 2005, and president of the Eastern Economic Association for 2006–2007. He is also the cofounder and chief economist of the investment management firm MacroMarkets LLC. Read more

Tommy Atlee '20 sits down with Economics Professor Robert Shiller, 2017 Truman Medal recipient and 2013 Nobel Prize in Economics Laureate, to talk about his background in economics and his thoughts for the future.

Click here to watch the interview

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