"Anticipating Asymmetrical Investor Reactions", Barra Newsletter, February 1990, p1
Topic: Asset Pricing and Valuation |
Asset Class: Equities
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In 1989 (Barra U.S. Newsletter #115, "Observations on Investor Reaction to Exceptional Returns," pp. 4-7), we proposed that a persistent asymmetry may exist between investors' reactions to extreme winners and extreme losers. Investors seem to cash out on extreme winners much sooner than they buy into extreme losers. We suggested this asymmetry was due to natural human cynicism. People have a tendency to be more averse to suffering losses than to forgoing subsequent gains, as Tversky and Kahneman have illustrated. (1) Whatever its cause, the asymmetry can be exploited if it persists. In 1989, we suggested a hedge strategy based on exploiting this asymmetry. In this article, we present an analysis of the actual performance the strategy would have generated. We used Barra's PC-based IPORCH program to generate the portfolio last year, and the new PC-based Performance System to analyze the results.
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Authors: Source: Barra Newsletter
"The Sponsor's View of Risk", Barra Newsletter, November 1989, p16
Topic: Asset Allocation and Asset Liability Management |
Asset Class: Multi-Asset Class
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The whole is not the sum of its parts as far as investment risk is concerned. The same diversification of risk that makes portfolio management interesting at the individual manager's level also applies at the aggregate level and makes the management of managers a game that calls for skill and perspective. The message of this paper is that sponsors should look at portfolio risk in the aggregate. An aggregate view makes the cost of aggressiveness for active managers far smaller when viewed in the aggregate than when each manager is viewed in isolation. Multiple managers offer sponsors great diversification benefits; but sponsors need to adapt policy to take advantage of those diversification benefits.
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Authors: Source: Barra Newsletter
"Forecasting Covariance", Barra Newsletter, July 1989, p1
Topic: Factor and Risk Modeling |
Asset Class: Multi-Asset Class
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The material in this article is taken from a presentation at the annual research seminar at Pebble Beach, June 4-8, 1989. Covariance is a measure of the linear relation between two random variables. On average, if the monthly returns in 1988 from holding IBM stock were positive (negative) when the returns from holding Southwest Gas were negative (positive), then the returns on these two stocks are said to exhibit negative covariance. What is the appropriate frequency to measure covariance? Is it reasonable to assume that covariance is constant over time? Is the covariance between two stock returns for the next month predictable?
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Authors: Source: Barra Newsletter
"A Barra View of Active Management --Part 2", Barra Newsletter, June 1989, p1
Topic: Investing (Investment Management) |
Asset Class: Fixed Income
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In the May 1989 Barra U.S. Newsletter ("A Barra View of Active Management"), we began a series on active management by talking about utility as the key concept in Barra's approach to this management style. We took as an example a highly quantitative manager using a dividend discount model as their sole source of active management information. This month, we use a completely different manager style as an example. This month's manager does not quantify judgements in terms of expected returns. We consider this manager to be non-quantitative in the sense that their judgements are expressed in a non-quantitative fashion. Will a manager with a non-quantitative way of expressing their views be able to build improved portfolios by increasing utility?
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Authors: Source: Barra Newsletter
"Report from the Equity Research Seminar, Part V: Value Added Continued", Barra Newsletter, March 1989, p8
Topic: Performance Analysis |
Asset Class: Equities
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In Part IV we discussed value added. The two key constructs in that discussion were the use of the expected utility of active return as a measure of value added and the use of a manager's information ratio as an indication of the manager's opportunity to add value. In this article, we investigate the determinants of the information ratio to find the sources of the manager's opportunity and thus the manager's ability to add value. We also propose a formula that can serve as a useful guide when making strategic investment policy decisions.
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Authors: Source: Barra Newsletter
"Foreign Exchange Option Pricing", Barra Newsletter, February 1989, p12
Topic: Asset Pricing and Valuation |
Asset Class: Derivatives
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Currency options are useful tools for taking one-sided currency bets and can be replicated to produce multi-currency option coverage such as the currency exposure implicit in an EAFE fund. European FX options are priced like Black-Scholes stock options where the stock pays a continuous proportional dividend. Option replication is complicated and requires a good understanding of the sources of risk including exchange rates, interest rates, time decay, volatility, and counterparty.
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Authors: Source: Barra Newsletter
"Confessions of a Pool Player: Humility and Active Management", Barra Newsletter, December 1989/January 1990, p 5
Topic: Investing (Investment Management) |
Asset Class: Multi-Asset Class
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The ingredients needed for successful active management are luck, skill, and humility. Luck and skill are obviously valuable. Humility, as in knowing what you don't know, is required when luck fails. This article shows how humility can work to your advantage. Humility places the burden of proof on the active decision. It forces the manager first to decide what portfolio to hold when he or she has no insights, and then to justify deviations from that original portfolio due to his or her particular insights. Deviations need to be justified with expectations of compensating return, and a method of portfolio construction should be used to make sure that the highest level of expected return is attained per unit of risk.
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Authors: Source: Barra Newsletter
"Uses and Abuses of Convexity", Barra Newsletter, November 1988, p3
Topic: Investing (Investment Management) |
Asset Class: Fixed Income
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A popular technique in the fixed income world is linking the percentage price change of a bond (for a given change in yield) to the bond's duration and convexity. This technique makes use of a Taylor series expansion and the idea that duration and convexity are variants of the first and second derivatives of the valuation equation. Much has been made elsewhere of the drawbacks of using duration and convexity as the only measures of a bond's risk, or even as measures of the bond's interest rate risk. This article explores the paradoxes that arise in modelling optionable bonds and the representation of price changes through a Taylor series expansion.
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Authors: Source: Barra Newsletter
"Report from the Seventh Fixed Income Seminar, Part V: Bond/Equity Market Linkages", Barra Newsletter, May 1988, p5
Topic: Investing (Investment Management) |
Asset Class: Fixed Income
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Barra's annual Fixed Income Seminar took place in October 1987, one week before the infamous stock market crash of October 19. At that time we noted an extremely rare event that had already occurred in the year's financial markets. For the first time in recent history, fixed income and equity returns were not only moving in different directions, but were correlated at an unprecedented - .44.(1) Historically, of course, changes in interest rates have had parallel, driving effects on both the bond and stock markets. Prompted in part by the surprising events of 1987, we decided to take a closer look not only at the links between the stock and bond markets as a whole, but also at connections between common factors in these markets.
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Authors: Source: Barra Newsletter
