Wednesday, April 27, 2011

A few on business education.

More on the perpetual hand-ringing of whether business education is relevant.

From the Financial Times.
and a few from Craig Newmark.

Doing nothing is an option

Real options are common in business - they represent the value of being able to choose to do something in the future.  An example of a real option is the option to expand production of a product if initial sales look good.

But real options can also include the option to not do something, as in the case of not drilling for oil when it might be more profitable to wait.  Unfortunately, the Federal Government doesn't understand real options and Felix has the story.

Does beta predict returns?

Fama and French answer the age old question: do high beta stocks outperform low beta stocks?   Their answer is yes, but not by as much as they should.

Why analysts hate to give sell ratings

Felix Salmon discusses why analysts don't like to give sell recommendations.  As I've said in class, analyst stock recommendations are largely useless.

Shiller and Siegel on Stock Market Valuation.

Robert Shiller and Jeremy Siegel go to the mat on stock valuation.

HT Greg Mankiw

Hedge Funds Bring Suckers...

Why investing in hedge funds is a bad idea.

HT: Felix Salmon

Tuesday, April 19, 2011

Diversification by Omission?

Ken French talks about the effect of omission on diversification.
Key point - its not just all about correlations.  Raw variances matter too.

The idea of bets by omission is a really important one and something I recently talked about with Ron Elmer who is the author of "The 401K Cook Book".  Ron's point is that many portfolio managers who are benchmarked against the S&P 500 hold only a fraction of the 500 stocks in the index.  Perhaps the stocks that they hold are the ones that they feel most strongly about.  Or perhaps they just don't have the man power to examine all 500 stocks.  Either way, the stocks that they don't hold actually represent a bet against those stocks.  In effect they are underweight those stocks.

We should be very careful to think about what we are not including in our portfolios because these "omissions" actually represent unintended bets against those securities.

Saturday, April 9, 2011

Do dividend paying stocks beat the market?

Reposted from Craig Newmark's blog, an article that claims that dividend paying stocks beat the market. I won't argue with the overall finding.  I am sure it is true for the 1993-2007 time period.  However, this doesn't mean that it has predictive ability for the future.  The article smells strongly of data mining.  

In the middle of the study period, the tech bubble burst, resulting in a massive loss in value for tech stocks, who tend to be non-dividend payers.  

The moral of the story is that you can pretty much show any trading rule if you pick the right data and the right time period.

As a side note, my students should note that alpha is incorrectly estimated here because the study uses raw and not excess returns.

What is the optimal global weighting system?

Portfolio theory states that if we believe market prices are correct, then the optimal weighting system for a portfolio should be based on market values.   Fama and French tackle the question of what happens when you factor in local market distortions that may provide a home market bias.

The answer is messy.  But at the end of the day, diversification is what counts.

A few on High Frequency Trading.

High Frequency Trading (HFT) is the practice of taking very short term positions to take advantage of small mispricings.  These mispricings are usually caused by inefficiencies in market structure rather than substantive deviations from fundamentals.  HFT makes up 70% of stock market volume.

1. A Nobel Prize winner thinks it should be banned outright (in the video he talks about some other policy stuff first).

2. It turns out that the limiting factor in HFT is the speed of light.   Apparently this limits the ability to pursue certain trades.   A map shows the optimal locations for trading centers.

3.To make things "fair" in the trading center next to the NYSE, the so-called "co-location facility", the NYSE is using the same cable length for all the different trading outfits.

4. Research on the whether HFT is beneficial suggests that HFT may improve price discovery - in other words it makes markets more efficient.