While the world seems to have a solution for every problem, an app for everything, one simple problem about Bubbles and Crisis bother no one. How to make bubbles less bubbly and crisis less severe. We are so busy counting our crypto wealth, it does not bother us whether the wealth is here tomorrow and gone tomorrow. We write stories about how Google sentiment drives bitcoin prices or vice versa, unaware of the fact that a few decades ago we were wondering whether the sunspots used to lead the economic cycle or vice versa. The fragmented nature of our research and markets and focus on causality is the reason we are happy betting on alpha as alphabets rule the world and not focus on alphabots that allow disruption for the general good.
The recent paper “Why Indexing works” [1] gives a probabilistic explanation of the futility of the Active process and why Passive Indexing is hard to beat. For every 1000 people who read the Wall Street Journal, maybe 10 read the Bloomberg Markets (BM) magazine and for every 10 who read the last month’s issue of BM maybe 1 read this research paper cited in the article [2]. And you don’t need a geologist to tell you that the chances to dig and find are small. This is why making a mathematical case against the underperformance of the USD 16 trillion plus active market using hypothetical probabilities is not easy.
AI is excited about jumping cats, How come AI can not solve the US 100 trillion investment management which can not beat the benchmark? The answers I got. The cat is important not the benchmark. AI needs to take small steps. Solving Cancer more important than beating the benchmark. Driverless cars more important focus. We don’t have another financial crisis to ask that question.
Finance is a key milestone for AI. Imagine coming back from vacation and talking to your virtual assistant about your investment portfolio and wondering how she does it, quarter after quarter, year after year.
Finance does not understand the physics of preferential attachment. According to Taleb, the intuitively appealing preferential attachment is incomplete. This is a tragedy for his ‘Black Swan’ because preferential attachment is the other name for ‘Rich Get Richer’. Taleb bases his philosophy of randomness on the non-normal power law behavior which is also another way of looking at ‘Rich Get Richer’ mathematics.
The two Nobel Prizes awarded in Economics in 1990 [1] and 2013 [2] define the boundaries of Modern Portfolio Theory (MPT). Size is the pillar for both the models.
When you make a big claim, you have to be careful. This is the lesson hardest to learn. I am still learning it. My stock market education helped me a lot. The one thing it always taught me was to be ready for a surprise.
Standing against the establishment, having a voice and speaking up needs courage. This is what you did. You spoke up against the industry which started the first Mutual Fund in 1775. Bloomberg calls it a revolution, you call it a revolution, Wall Street Journal is calling it differently, but that does not matter. Mutual Funds are in a descent. Stock Pickers might still continue to follow Graham and Dodd approach, but the facts are overwhelming. If an institution can’t beat the index then it is wasting resources.
Though ‘Size’ is the most important factor explaining stock market returns, the possibility of size being a proxy was first mentioned in Banz (1978). Even after forty years of factor investing the industry is still looking for answers. This paper chronologically lists the research on ‘Size’ and why the question regarding ‘The Size Proxy’ has never been so relevant.
Before we talk about Blockchain disruption, let us talk about the implosion happening on Wall Street. The Realization that stock picking is dead [1] after decades of Active underperformance [2] has made beating the market an adventure sport, where only a few succeed.
If you can explain your money management innovation (rule-based portfolios) to your mom, it is golden. My mom gets it. Succeeding in selling and marketing a new financial innovation just like any other innovation will be about design. If it is not intuitive, no overselling, branding and marketing money is going to stop the jumping from the ship.
While Robert Solow suggested not to think of Economics as Science [1], Andrew Lo warned us about the dangers of using Physics to build economic systems [2]. Physics has been a late entrant to the world of Finance.
Investment management which is worth USD 70 trillion can be seen like a fruit basket. The job of the fund manager was to select the fruits from the market and sell it to the investor.
The rich do not always get richer. Explaining this probabilistically resolves a 100-year-old puzzle, opening up opportunities for smart beta portfolios, an architecture of complexity and eventually an architecture of data that could become Web 4.0.
Ok! advisors might be inefficient but is it enough reason for the media wave against them. Agreed that evolution has to happen, and after the industry restructured broking, sized up researchers, and the equity sales, maybe it’s time to disrupt advising. One may argue that somebody has to take the responsibility for underperformance netted for a fee, so maybe it’s time for retribution for advisors. But before we choose the robots over the advisors, and see passive investing as a solution for all investing, maybe we need another perspective.
Despite its popularity, the power law has not been without its failures and has rather come under criticism. In the paper ‘Scale-dependent price fluctuations for the Indian stock market’, Matia K, Pal M, Salunkay H, Stanley HE (2004), the authors explained how Indian stock market may belong to a universality of class different than that observed in developed markets.
Adaptive Market Hypothesis (AMH) embraces Efficient Market Hypothesis (EMH) as an idealization that is economically unrealizable, but which serves as a useful benchmark for measuring relative efficiency.
I was in Mumbai recently, meeting fund managers to understand where India was on the smart beta road. How fast was investor education evolving? What was the appetite for ETF’s? And what should be done from the regulation point of view to take the Indian markets to the next stage?
Jules Augustin Frédéric Regnault was a French stock broker's assistant who first suggested a modern theory of stock price changes in Calcul des Chances et Philosophie de la Bourse (1863) and used a random walk model. He is also one of the first authors who tried to create a "stock exchange science" based on a statistical and probabilistic analysis. His hypotheses were used by Louis Bachelier, who is considered a pioneer in the study of financial mathematics. Bachelier had anticipated many of the mathematical results developed in Albert Einstein’s 1905 paper.
John Rae’s inter-temporal choices explained the statistical nature of human behavior in 1834. However, despite the subject’s insight in the objectiveness of behavior, inter-temporal choices remains a peripheral science. This paper takes a sequential approach to question how inter-temporal choices could be behind human behavior, behavioral anomalies and even market anomalies. If these inter-temporal anomalies were consistent, unarbitrageable and explain asset returns better than the Fama and French Factor model, this could further our understanding of asset pricing models by establishing a new duration factor which could subsume both size and value factors.