Wilmott Magazine: September 2015 issue

Volume 2015, Issue 79. Pages 1–72

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Every issue we bring you original material from some of the best columnists, educators and cutting-edge researchers. In this issue:

Bibliography

  • “Contents,” Wilmott, vol. 2015, iss. 79, p. 1–1, 2015. doi:10.1002/wilm.10438
    [BibTeX] [Download PDF]
    @article {WILM:WILM10438,
    title = {Contents},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10438},
    doi = {10.1002/wilm.10438},
    pages = {1--1},
    year = {2015},
    }

  • D. Tudball, “Ed’s letter: don’t want to burst your bubble (but you’ve got trouble),” Wilmott, vol. 2015, iss. 79, p. 2–3, 2015. doi:10.1002/wilm.10439
    [BibTeX] [Abstract] [Download PDF]

    Among the first to warn of the global financial crisis that begin with the collapse of subprime mortgages in 2007.

    @article {WILM:WILM10439,
    author = {Tudball, Dan},
    title = {Ed's Letter: Don't Want to Burst Your Bubble (But You've Got Trouble)},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10439},
    doi = {10.1002/wilm.10439},
    pages = {2--3},
    year = {2015},
    abstract = {Among the first to warn of the global financial crisis that begin with the collapse of subprime mortgages in 2007.},
    }

  • “News,” Wilmott, vol. 2015, iss. 79, p. 4–11, 2015. doi:10.1002/wilm.10440
    [BibTeX] [Download PDF]
    @article {WILM:WILM10440,
    title = {News},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10440},
    doi = {10.1002/wilm.10440},
    pages = {4--11},
    year = {2015},
    }

  • A. Brown, “The american 20th century in three episodic novels by poker players,” Wilmott, vol. 2015, iss. 79, p. 12–13, 2015. doi:10.1002/wilm.10441
    [BibTeX] [Abstract] [Download PDF]

    Examining the legacy of three books whose honesty transcends factual truth, capturing defining moments in the history of (so far) humankind’s most violent, eventful, and productive century in (so far) humankind’s most violent, eventful, and productive country…

    @article {WILM:WILM10441,
    author = {Brown, Aaron},
    title = {The American 20th Century in Three Episodic Novels by Poker Players},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10441},
    doi = {10.1002/wilm.10441},
    pages = {12--13},
    year = {2015},
    abstract = {Examining the legacy of three books whose honesty transcends factual truth, capturing defining moments in the history of (so far) humankind's most violent, eventful, and productive century in (so far) humankind's most violent, eventful, and productive country…},
    }

  • S. Das, “Swiss finish – lessons for central bankers?,” Wilmott, vol. 2015, iss. 79, p. 14–17, 2015. doi:10.1002/wilm.10442
    [BibTeX] [Abstract] [Download PDF]

    The fallout from the decision of the Swiss National Bank (SNB) to abandon a fixed value of the Swiss franc (CHF) against the euro may foreshadow the potential consequences of the end or failure of central bank activism. As Gloucester in Shakespeare’s King Lear states: “These late eclipses of the sun and moon portend no good to us.”

    @article {WILM:WILM10442,
    author = {Das, Satyajit},
    title = {Swiss Finish – Lessons for Central Bankers?},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10442},
    doi = {10.1002/wilm.10442},
    pages = {14--17},
    year = {2015},
    abstract = {The fallout from the decision of the Swiss National Bank (SNB) to abandon a fixed value of the Swiss franc (CHF) against the euro may foreshadow the potential consequences of the end or failure of central bank activism. As Gloucester in Shakespeare's King Lear states: “These late eclipses of the sun and moon portend no good to us.”},
    }

  • L. C. MacLean and B. Ziemba, “Primer on stochastic dominance,” Wilmott, vol. 2015, iss. 79, p. 18–21, 2015. doi:10.1002/wilm.10443
    [BibTeX] [Abstract] [Download PDF]

    In the problem of financial decision making under uncertainty, the accumulated capital from investing in risky assets is a random variable. The preference for random variables can be expressed in terms of the characteristics of their distributions with the order relations of stochastic dominance.

    @article {WILM:WILM10443,
    author = {MacLean, Leonard C. and Ziemba, Bill},
    title = {Primer on Stochastic Dominance},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10443},
    doi = {10.1002/wilm.10443},
    pages = {18--21},
    year = {2015},
    abstract = {In the problem of financial decision making under uncertainty, the accumulated capital from investing in risky assets is a random variable. The preference for random variables can be expressed in terms of the characteristics of their distributions with the order relations of stochastic dominance.},
    }

  • D. Ingram, “Walking into the tails of risk models one standard deviation at a time,” Wilmott, vol. 2015, iss. 79, p. 22–27, 2015. doi:10.1002/wilm.10444
    [BibTeX] [Abstract] [Download PDF]

    To date, there is no established language to talk about the nature of that extrapolation. The CoR described here bridges that gap.

    @article {WILM:WILM10444,
    author = {Ingram, David},
    title = {Walking Into the Tails of Risk Models One Standard Deviation at a Time},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10444},
    doi = {10.1002/wilm.10444},
    pages = {22--27},
    year = {2015},
    abstract = {To date, there is no established language to talk about the nature of that extrapolation. The CoR described here bridges that gap.},
    }

  • R. Shiller and G. Caginalp, “‘new normal’ is a name for a fear and, unfortunately, roosevelt was right,” Wilmott, vol. 2015, iss. 79, p. 28–37, 2015. doi:10.1002/wilm.10445
    [BibTeX] [Abstract] [Download PDF]

    Beacon of empiricism, nemesis of the efficient markets hypothesis, and Nobel Prize winner Robert Shiller speaks to Gunduz Caginalp about the new edition of Irrational Exuberance and the truth behind the ‘new normal’

    @article {WILM:WILM10445,
    author = {Shiller, Robert and Caginalp, Gunduz},
    title = {‘New Normal’ is a Name for a Fear and, Unfortunately, Roosevelt Was Right},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10445},
    doi = {10.1002/wilm.10445},
    pages = {28--37},
    year = {2015},
    abstract = {Beacon of empiricism, nemesis of the efficient markets hypothesis, and Nobel Prize winner Robert Shiller speaks to Gunduz Caginalp about the new edition of Irrational Exuberance and the truth behind the ‘new normal’},
    }

  • S. Ahlawat, “Probabilistic neural networks for identification and empirical evaluation of technical analysis-based forecasting,” Wilmott, vol. 2015, iss. 79, p. 38–49, 2015. doi:10.1002/wilm.10446
    [BibTeX] [Abstract] [Download PDF]

    Technical analysis is frequently dismissed as an exercise in data snooping by practitioners of quantitative finance because of its lack of rigorous theoretical underpinnings. An empirical evaluation of the effectiveness of technical analysis is confounded by the subjectivity involved in identifying patterns – a higher degree of smoothing in one region may reveal patterns that were previously obscured by local noise, or it could obscure an uncovered pattern that was waiting to be identified by a technical analyst. In a seminal paper on empirical assessment of technical analysis, Lo, Mamaysky, and Wang use kernel smoothing on price charts to represent a smoothed price plot before applying geometric rules based on the order of local extrema to identify patterns used in technical analysis. The authors acknowledge the shortcomings of the procedure: constant smoothing parameter for entire price history, prescription of smoothing parameter after visual inspection of smoothed plots, and shortcomings inherent in the use of kernal smoothing-like edge effects. Because their procedure identifies patterns based on the order of local maxima, a constant smoothing parameter is the biggest shortcoming of their algorithm – a different smoothing pattern in one region may reveal patterns that could not be discerned using existing smoothing parameters. This paper presents a more robust framework of pattern identification using probabilistic neural networks (PNNs). PNNs were chosen over other variants of neural networks – like back-propagation-based multi-layer neural networks – because of the shorter training period and the relative simplicity involved in network construction for PNNs. A set of well-known patterns is selected, and a PNN is used to identify the technical patterns observed in the price history for 30 Dow Jones Industrial components and for the S&P 500 index. Statistical tests are performed to gauge the empirical significance of profits derived from trading based on the respective technical patterns. A trading rule is added to supplement the pattern identification process and statistical tests are used to assess its profitability.

    @article {WILM:WILM10446,
    author = {Ahlawat, Samit},
    title = {Probabilistic Neural Networks for Identification and Empirical Evaluation of Technical Analysis-Based Forecasting},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10446},
    doi = {10.1002/wilm.10446},
    pages = {38--49},
    keywords = {technical analysis, chart patterns, neural network, PNN, charting, trading strategy},
    year = {2015},
    abstract = {Technical analysis is frequently dismissed as an exercise in data snooping by practitioners of quantitative finance because of its lack of rigorous theoretical underpinnings. An empirical evaluation of the effectiveness of technical analysis is confounded by the subjectivity involved in identifying patterns – a higher degree of smoothing in one region may reveal patterns that were previously obscured by local noise, or it could obscure an uncovered pattern that was waiting to be identified by a technical analyst. In a seminal paper on empirical assessment of technical analysis, Lo, Mamaysky, and Wang use kernel smoothing on price charts to represent a smoothed price plot before applying geometric rules based on the order of local extrema to identify patterns used in technical analysis. The authors acknowledge the shortcomings of the procedure: constant smoothing parameter for entire price history, prescription of smoothing parameter after visual inspection of smoothed plots, and shortcomings inherent in the use of kernal smoothing-like edge effects. Because their procedure identifies patterns based on the order of local maxima, a constant smoothing parameter is the biggest shortcoming of their algorithm – a different smoothing pattern in one region may reveal patterns that could not be discerned using existing smoothing parameters. This paper presents a more robust framework of pattern identification using probabilistic neural networks (PNNs). PNNs were chosen over other variants of neural networks – like back-propagation-based multi-layer neural networks – because of the shorter training period and the relative simplicity involved in network construction for PNNs. A set of well-known patterns is selected, and a PNN is used to identify the technical patterns observed in the price history for 30 Dow Jones Industrial components and for the S&P 500 index. Statistical tests are performed to gauge the empirical significance of profits derived from trading based on the respective technical patterns. A trading rule is added to supplement the pattern identification process and statistical tests are used to assess its profitability.},
    }

  • K. Smith, “The financial economic risk in financial engineering models,” Wilmott, vol. 2015, iss. 79, p. 50–55, 2015. doi:10.1002/wilm.10447
    [BibTeX] [Abstract] [Download PDF]

    Current models for valuing and hedging exotic FX options under the smile still exhibit, as their counterparts did a decade ago, widely dispersed predictions of market value that are disarticulated from traded market hedging costs. Since fitting to ever-expanding calibration sets and implying model hedges has not solved the problem, this paper considers the possibility that fitting and implying are the problem. It finds that financial engineering does not closely reflect the financial economics of intermediation that is fundamental to the creation of, and price making in, derivative products. By not reflecting the economics of intermediating market risk, financial engineering has difficulty in accurately predicting the value of market risk to an intermediary.

    @article {WILM:WILM10447,
    author = {Smith, Kurt},
    title = {The Financial Economic Risk in Financial Engineering Models},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10447},
    doi = {10.1002/wilm.10447},
    pages = {50--55},
    keywords = {xotic options, financial engineering, financial economics, financial intermediation},
    year = {2015},
    abstract = {Current models for valuing and hedging exotic FX options under the smile still exhibit, as their counterparts did a decade ago, widely dispersed predictions of market value that are disarticulated from traded market hedging costs. Since fitting to ever-expanding calibration sets and implying model hedges has not solved the problem, this paper considers the possibility that fitting and implying are the problem. It finds that financial engineering does not closely reflect the financial economics of intermediation that is fundamental to the creation of, and price making in, derivative products. By not reflecting the economics of intermediating market risk, financial engineering has difficulty in accurately predicting the value of market risk to an intermediary.},
    }

  • Z. Kakushadze, “4-factor model for overnight returns,” Wilmott, vol. 2015, iss. 79, p. 56–63, 2015. doi:10.1002/wilm.10448
    [BibTeX] [Abstract] [Download PDF]

    We propose a 4-factor model for overnight returns and give explicit definitions of our 4 factors.1 Long-horizon fundamental factors such as value and growth lack predictive power for overnight (or similar short-horizon) returns and are not included. All 4 factors are constructed based on intraday price and volume data and are analogous to size (price), volatility, momentum, and liquidity (volume). Historical regressions à la Fama and MacBeth (1973) suggest that our 4 factors have sizable serial t-statistic and appear to be relevant predictors for overnight returns. We check this by using our 4-factor model in an explicit intraday mean-reversion alpha.

    @article {WILM:WILM10448,
    author = {Kakushadze, Zura},
    title = {4-Factor Model for Overnight Returns},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10448},
    doi = {10.1002/wilm.10448},
    pages = {56--63},
    year = {2015},
    abstract = {We propose a 4-factor model for overnight returns and give explicit definitions of our 4 factors.1 Long-horizon fundamental factors such as value and growth lack predictive power for overnight (or similar short-horizon) returns and are not included. All 4 factors are constructed based on intraday price and volume data and are analogous to size (price), volatility, momentum, and liquidity (volume). Historical regressions à la Fama and MacBeth (1973) suggest that our 4 factors have sizable serial t-statistic and appear to be relevant predictors for overnight returns. We check this by using our 4-factor model in an explicit intraday mean-reversion alpha.},
    }

  • C. Lo, “Pricing spread options by the operator splitting method,” Wilmott, vol. 2015, iss. 79, p. 64–67, 2015. doi:10.1002/wilm.10449
    [BibTeX] [Abstract] [Download PDF]

    Based upon the Strang operator splitting method, we have presented a simple approach to improve Kirk’s approximation for spread options in a straightforward manner. Illustrative numerical examples have demonstrated that our proposed approximation scheme is able to provide very accurate estimates of the option prices without compromising the efficiency of Kirk’s approximation. As the approximate option prices are given in closed form, analytical formulae for the Greeks can be derived explicitly. Moreover, since the proposed approach is simple and straightforward, we believe that it can be easily applied to the multi-asset spread options as well.

    @article {WILM:WILM10449,
    author = {Lo, Chi-Fai},
    title = {Pricing Spread Options by the Operator Splitting Method},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10449},
    doi = {10.1002/wilm.10449},
    pages = {64--67},
    keywords = {Black-Scholes equation, spread options, Kirk's approximation, Lie-Trotter operator splitting approximation, Strang operator splitting approximation},
    year = {2015},
    abstract = {Based upon the Strang operator splitting method, we have presented a simple approach to improve Kirk's approximation for spread options in a straightforward manner. Illustrative numerical examples have demonstrated that our proposed approximation scheme is able to provide very accurate estimates of the option prices without compromising the efficiency of Kirk's approximation. As the approximate option prices are given in closed form, analytical formulae for the Greeks can be derived explicitly. Moreover, since the proposed approach is simple and straightforward, we believe that it can be easily applied to the multi-asset spread options as well.},
    }

  • S. Das, “One thing after another!,” Wilmott, vol. 2015, iss. 79, p. 68–69, 2015. doi:10.1002/wilm.10450
    [BibTeX] [Abstract] [Download PDF]

    The 19th century in all its complexity and confusion.

    @article {WILM:WILM10450,
    author = {Das, Satyajit},
    title = {One Thing After Another!},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10450},
    doi = {10.1002/wilm.10450},
    pages = {68--69},
    year = {2015},
    abstract = {The 19th century in all its complexity and confusion.},
    }

  • M. Radley, “Cars,” Wilmott, vol. 2015, iss. 79, p. 70–71, 2015. doi:10.1002/wilm.10451
    [BibTeX] [Abstract] [Download PDF]

    Just to show that it is serious about competing in every sports car segment, McLaren launches its smallest supercar to date.

    @article {WILM:WILM10451,
    author = {Radley, Milford},
    title = {Cars},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10451},
    doi = {10.1002/wilm.10451},
    pages = {70--71},
    year = {2015},
    abstract = {Just to show that it is serious about competing in every sports car segment, McLaren launches its smallest supercar to date.},
    }

  • J. Jarasz, “The skewed world of jan jarasz,” Wilmott, vol. 2015, iss. 79, p. 72–72, 2015. doi:10.1002/wilm.10452
    [BibTeX] [Download PDF]
    @article {WILM:WILM10452,
    author = {Jarasz, Jan},
    title = {The skewed world of Jan Jarasz},
    journal = {Wilmott},
    volume = {2015},
    number = {79},
    publisher = {John Wiley & Sons, Ltd},
    issn = {1541-8286},
    url = {http://dx.doi.org/10.1002/wilm.10452},
    doi = {10.1002/wilm.10452},
    pages = {72--72},
    year = {2015},
    }

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