Methods for Trading and InvestmenteBook

Methods for Trading and Investment

Portfolio Analysis Using Excel...


9. "Portfolio Analysis Using Excel" by J. Laws analyses the familiar Markovitz model using Excel. This topic is taught on Finance degrees and Master's programmes all over the world, increasingly through the use of Excel. The author takes time out to explain how the spreadsheet is set up and how simple short cuts can make analysis of this type of problem quick and straightforward. In the first section of the chapter the author uses a two variable example to show how portfolio risk and return vary with the input weights, then he goes on to show how to determine the optimal weights, in a risk minimisation sense, using both linear expressions and matrix algebra. In the second part of the chapter the author extends the number of assets to seven and illustrates that using matrix algebra within Excel, the Markovitz analysis of an n-asset portfolio is as straightforward as the analysis of a two asset portfolio. The author takes special care in showing how the correlation matrix can be generated most efficiently and how within the same framework the optimisation objective can be modified without fuss.
10. "Applied Volatility and Correlation Modelling Using Excel" by F. Bourgoin. The originality of this chapter lies in the fact that the author manages to implement a range of univariate and multivariate models within the software package, Excel. This is extremely useful as a large proportion of finance practitioners, students and researchers are familiar with this package. Using S&P500 return data the author generates one step ahead forecasts of volatility using the J.P. Morgan RiskMetrics model, the J.P. Morgan RiskMetrics model with optimal decay, a GARCH(1,1) model with and without a variance reduction technique and finally using the GJR model to account for asymmetric reaction to news. A comparison of forecasts is made and some useful insights into the efficacy of the models highlighted. In the second part of the chapter the author uses return data on the DAX30 and CAC40 to model the correlation structure using a number of models. As with the univariate approach this includes the J.P. Morgan RiskMetrics model with and without optimal decay, a GARCH model with and without variance reduction and finally the so called "Fast GARCH" model of which the author has previously made significant contributions to the literature.
11. "Optimal Allocation of Trend Following Rules: An Application Case of Theoretical Results" by P. Lequeux uses sophisticated Excel modelling tools to determine what should be the optimal weighting of trading rules to maximise the information ratio. The trading rules utilised in the chapter are moving average trading rules ranging in order from 2 to 117 days and they are applied to a sample of five currency pairs (USD-JPY, EUR-USD, GBP-USD, USD-CAD and AUD-USD) over the period 15/02/1996 to 12/03/2002. The analysis could however be applied to any financial asset and any linear trading rule. In the applied example the author attempts to determine ex-ante what would be the optimal weighting between moving averages of order 2, 3, 5, 9, 32, 61 and 117 to maximise the delivered information ratio. To assist in understanding, the model has been programmed into a spreadsheet to give the reader the possibility to experiment. The results show that in four currency pairs out of five the optimal weighting procedure is superior, when measured by the information ratio, to an equally weighted basket of trading rules.
12. "Portfolio Management and Information from Over the Counter Currency Options" by J. B. Luis: this chapter looks at the informational content of risk reversals and strangles derived from OTC at the money forward volatilities. Three empirical applications of the literature are presented: one on the EUR/USD, followed by the analysis of implied correlations and the credibility of the Portuguese exchange rate policy during the transition to the EMU, and of the Danish exchange rate policy around the euro referendum in September 2000. This chapter is supported by the necessary Excel files to allow the reader to validate the author's results and/or apply the analysis to a different dataset.
13. "Filling Analysis for Missing Data: An Application to Weather Risk Management" by C. L. Dunis and V. Karalis: this chapter analyses the use of alternative methods when confronted with missing data, a common problem when not enough historical data or clean historical data exist, which will typically be the case when trying to develop a decision tool either for a new asset in a given asset class (say a recently issued stock in a given company sector) or for a new asset class as such (for instance weather derivatives). The application to weather data derives from the fact that most weather derivatives pricing methodologies rely heavily on clean data. The statistical imputation accuracy of different filling methods for missing historical records of temperature data is compared: the Expectation Maximisation (EM) algorithm, the Data Augmentation (DA) algorithm, the Kalman Filter (KF), Neural Networks Regression (NNR) models and, finally, Principal Component Analysis (PCA). Overall, it is found that, for the periods and the data series concerned, the results of PCA outperformed the other methodologies in all cases of missing observations analysed.
Overall, the objective of Applied Quantitative Methods for Trading and Investment is not to make new contributions to finance theory and/or financial econometrics: more simply, but also more practically, it is to enable its readers to make competent use of advanced methods for modelling financial markets.

We hope that, with the numerous files and software programs made available on the accompanying CD-Rom, it will constitute a valuable reference textbook for quantitative market professionals, academics and finance graduate students. Many of the authors of chapters contained in this book have an affiliation to the Forecasting Financial Markets (FFM) conference which has been held each May since 1993. The editors of the text and several of the authors are members or associates of the Centre for International Banking, Economics and Finance (CIBEF) at Liverpool John Moores University. Details of both the conference and CIBEF may be found at www·cibef·com.
February 2003

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