Spring 2017

Carl-Fredrik Arndt, Two Sigma: Dynamics for the Top Eigenvalue and Eigenvector of Empirical Correlation Matrices of Financial Data

In this talk we will discuss how the top eigenvalue/eigenvector pair evolves through time for estimators of covariance and correlation matrices of equity return type data. By this we mean that the matrices have a top eigenvalue which is well separated from the others. Our main results are that both the eigenvalue and eigenvector of a correlation matrix has an extra stability effect, which has previously been observed empirically but to our knowledge never previously studied theoretically. Because of this, one has to use different methods for determining and studying the stationarity of...

Peter Shepard, MSCI: Second Order Risk

Managing a portfolio to a risk model can tilt the portfolio toward weaknesses of the model. As a result, the optimized portfolio acquires downside exposure to uncertainty in the model itself, what we call “second order risk.” We propose a risk measure that accounts for this bias. Studies of real portfolios, in asset-by-asset and factor model contexts, demonstrate that second order risk contributes significantly to realized volatility, and that the proposed measure accurately forecasts the out-of-sample behavior of optimized portfolios....

Terrence Hendershott, Haas School of Business: Relationship Trading in OTC Markets

We examine the network of bilateral trading relations between insurers and dealers in the over-the-counter corporate bond market. Using comprehensive regulatory data we find that many insurers use only one dealer while the largest insurers have a network of up to eighty dealers. To understand the heterogeneity in network size we build a model of decentralized trade in which insurers trade off the benefits of repeat business against more intense dealer competition. Empirically, large insurers form more relations and receive better prices than small insurers. The model matches both the...

Paul Kaplan, Morningstar: A Popularity Asset Pricing Model

This paper presents a formal model for theory of popularity as laid out informally by Idzorek and Ibbotson in their seminal paper, “Dimensions of Popularity (Journal of Portfolio Management, 2014). The paper does this by extending the capital asset pricing model (CAPM) to include security characteristics that different investors regard differently. This leads to an equilibrium in which: 1) The expected excess return on each security is a linear function of its beta and its popularity loadings which measure the popularity of the security based on its characteristics relative to the those of...

Adair Morse, Haas School of Business: A Popularity Asset Pricing Model

We study investments in impact funds, defined as venture capital or growth equity funds with dual objectives of generating financial returns and positive externalities. Being an impact fund elevates a fund’s marginal investment rate by 14.1% relative to a traditional VC fund, even more for funds focused on environmental, poverty, and minority/women issues. Europeans and UNPRI signatories have sharply higher demand for impact. Three investor attributes – household-backed capital, mission-oriented investors, and investors facing political/regulatory pressure to invest in impact – account for...

Kellie Ottoboni, UC Berkeley: "Simple Random Sampling: Not So Simple"

The theory of inference from simple random samples (SRSs) is fundamental in statistics; many statistical techniques and formulae assume that the data are an SRS. True random samples are rare; in practice, people tend to draw samples by using pseudo-random number generators (PRNGs) and algorithms that map a set of pseudo-random numbers into a subset of the population. Most statisticians take for granted that the software they use "does the right thing," producing samples that can be treated as if they are SRSs. In fact, the PRNG and the algorithm for drawing samples matter enormously. We...

Arnav Sheth, Saint Mary's College of California: Leveraging Herd Behavior in Foreign Exchange Markets

We examine the relationship between equity and foreign exchange markets at, and around, the WM/Reuters benchmark exchange rate known as the the `Fix'. Execution at the Fix is a service offered by brokers (normally banks) provided they obtain the trade order until a certain time prior to 4pm GMT (11 amEastern Time). This benchmark is used to value derivative contracts, measure portfolio tracking error for foreign benchmark equity indexes, and provide a reference exchange rate for purchasing foreign stocks. Given the importance of the Fix in...

Markus Pelger, Stanford University: Estimating Latent Asset-Pricing Factors

We develop an estimator for latent factors in a large-dimensional panel of financial data that can explain expected excess returns. Statistical factor analysis based on Principal Component Analysis (PCA) has problems identifying factors with a small variance that are important for asset pricing. Our estimator searches for factors with a high Sharpe-ratio that can explain both the expected return and covariance structure. We derive the statistical properties of the new estimator and show that our estimator can find asset-pricing factors, which cannot be detected with PCA, even if a large...