Highlights of the blog over the past year.

See also “Blog year 2010 in review”.

Most popular posts

The posts with the most hits during the year.

1. 4 and a half myths about beta in finance
2. A tale of two returns (posted in 2010)
3. The number 1 novice quant mistake
4. What the hell is a variance matrix? (posted in 2010)
5. On “Stock correlations have been rising”
6. The R Inferno revised
7. Factor models of variance in finance
8. Testing an S&P 500 prediction
9. Solve your R problems
10. The volatility mystery continues

Most under-valued posts

The things that are good for us — like eating spinach — are the things that we tend to avoid most.  Here are five topics from the past year that I think have the potential to move the fund management industry in a positive direction:

• Consider implementing pension insurance
• Switch to useful performance measurement
• Use risk models wisely
• Move away from short-termism
• If you are active, understand your edge

Book reviews

Table 1 summarizes (and has links to) the reviews of books during the year.

Table 1: Recommendations of reviewed books.

title	author	recommended
Risk and Meaning	Nicolas Bouleau	for some
23 Things They Don’t Tell You about Capitalism	Ha-Joon Chang	yes
Future Babble	Dan Gardner	highly
Numerical Methods and Optimization in Finance	Manfred Gilli, Dietmar Maringer, Enrico Schumann	I suspect so
Adapt	Tim Harford	highly
Expected Returns	Antti Ilmanen	yes
Boombustology	Vikram Mansharamani	yes
Smart Swarm	Peter Miller	yes
R Graphs Cookbook	Hrishi Mittal	mostly
Saving Capitalism from Short-Termism	Alfred Rappaport	yes
Everything is Obvious*	Duncan Watts	highly

Fund management

There were two posts concerned with Con Keating’s call for pension insurance.  This is an idea that isn’t in much favor in the English-speaking world, but perhaps should be.

I mused about the possibility of fund management capturing some of the money that is currently gambled away in “An investment lottery”.

Remember that valuation is hard. And here is one reason why and perhaps another.

Funny pages

• Boris the banker explains efficient markets
• A field guide to market participants
• Solve your R problems
• The carry trade — almost wordless

Performance

Performance will most probably be the major use of random portfolios at some point.  The post “Finding good active managers” explains why it would be better for that point to be sooner rather than later.

A refinement of the technique is reported in “Performance measurement is about decisions”.

Quant finance

The hottest quant topic was on variance compression.  That is, that in recent times volatility estimates of the S&P 500 using multiple-day returns are “too small” relative to estimates based on one-day returns.  There’s something happening there, but we don’t know what it is.

There was a post urging more understanding and less use of beta.  There was also a couple of posts about what happens when portfolios are constrained to have beta equal to one, and at least one other post about beta.

The number 1 novice quant mistake is to use prices instead of returns in models. Perhaps mistake number 2 is overfitting models. Somewhere down the list is computing realized portfolio returns.

Quantitative finance depends on data sources. A largely untapped data source is news analytics.

Factor models of variance were explained.  A series of posts comparing factor models and Ledoit-Wolf shrinkage point to Ledoit-Wolf being better for several uses.

Another series of posts suggest that weight constraints should often be replaced by constraints on variance fractions.  This can be done at the individual asset level but probably more usefully at a higher level.  Constraining sector fractions of variance is really what we are aiming at when we impose sector weight constraints.  A specific use of the idea of risk fraction is in risk parity portfolios.

Stock correlations were investigated. The sell-off in early August seemed to display a bit of a disconnect between the major American indices and typical constituents of the S&P 500. An index is merely a trading strategy made official.

Low volatility investing made a few appearances.

The asynchrony of market opening hours can cause problems. The problems and remedies were discussed.

The good news and the bad news of the predictability of skewness and kurtosis.

Winsorization was explained.

Surprisingly the Halloween indicator slash “go away in May” seems to have some reality to it (see the first comment, but why would there be such an effect?).

An introductory look at why continuously compounded returns are connected to natural logarithms.

There was also a look at performance ratios when return variances are infinite.

R

The R Inferno was revised in the spring. Amazingly, this blog got the world-wide scoop. Here is the advertisement.

useR!2011 inspired three posts.

There were reports on R/Finance and a LondonR meeting.

Also there was a particular post that I think is a great example of some of the power of R.

Risk

Danielsson and Macrae wrote a short and highly recommended piece on the appropriate use of risk models.  They aim at both practitioners and regulators.

Engineering has the concept of a normal accident.  This is the idea that a complex, highly interrelated system will go bad.  Often attempts to make the system safer just make it more complex and more likely to break.  You can get more about this in Tim Harford’s wonderful Adapt.

Normal accidents imply the Book of Doom.

A quite clever — I think — idea is to do premortem stress tests.  When a project is in development, each member of the team is required to state how the project will have failed given that it has failed.  The trick is to force people to think of failure seriously and to avoid ego problems.

There is a connection between risk management and Mayan hieroglyphics.  This concept is put into warp drive in Risk and Meaning.

Soundtrack

Porcelain Monkey

He was an accident waiting to happen
Most accidents happen at home
Maybe he should’ve gone out more often

Porcelain Monkey by Warren Zevon and Jorge Calderon

To an Athlete Dying Young

The time you won your town the race
We chaired you through the market-place;

To an Athlete Dying Young by A. E. Housman

Lawyers, Guns and Money

I was gambling in Havana
I took a little risk

from Lawyers, Guns and Money by Warren Zevon

Long Way Home

Money’s just something you throw
Off the back of a train

from Long Way Home by Tom Waits and Kathleen Brennan

Time is a Lion

But time is a story and there will be more

From Time is a Lion by Joe Henry

Just a Bum

He will tell ya it wasn’t always this way
One bad little thing happened one bad little day

from Just a Bum by Greg Brown

Stairway to Heaven

Yes, there are two paths you can go by, but in the long run
There’s still time to change the road you’re on

from Stairway to Heaven by Led Zeppelin

Easy Money

She said “I got a plan
Listen, Sam, how’d ya like to make some easy money ? ”
He say, “yes! oh yes!

from “Easy Money” by Rickie Lee Jones

The Wonderful Wizard

Just like a homeless, that hangs around your home
Or a mother who’d give away her own

from “The Wonderful Wizard” by Guggenheim Grotto

Deep Dark Truthful Mirror

You’re spellbound baby there’s no doubting that
Did you ever see a stare like a Persian cat?

from “Deep Dark Truthful Mirror” by Declan MacManus

For my next trick I’ll need a voluteer

I can saw a woman in two
But you won’t want to look in the box when I do

from “For my next trick I’ll need a volunteer” by Warren Zevon

1952 Vincent Black Lightning

Red hair and black leather my favourite colour scheme

from “1952 Vincent Black Lightning” by Richard Thompson

Elephants

Throw yourself in the midst of danger but keep one eye open at night

Handcuffed to a Fence in Mississippi

things is always better than they seem

from “Handcuffed to a Fence in Mississippi” by Jim White

Things That Scare Me

Same birds that followed me
To school when I was young
Were they trying to tell me something?
Were they tellin’ me to run?

from “Things That Scare Me” by Neko Case and Tom Ray

Down the Mountain

Who would take the repercussions when the bottle is to blame?

from “Down the Mountain” by Robin E. Contreras

Don’t Stop

Why not think about times to come

from “Don’t Stop” by Christine McVie

Two Tramps in Mud Time

You know how it is with an April day
When the sun is out and the wind is still,
You’re one month on in the middle of May.

from “Two Tramps in Mud Time” by Robert Frost

Ballad of a Thin Man

And something is happening here
But you don’t know what it is
Do you, Mister Jones ?

from “Ballad of a Thin Man” by Bob Dylan

Hallelujah

And all I ever learned from love
Was how to shoot someone who outdrew ya

from “Hallelujah” by Leonard Cohen

(Looking for) The Heart of Saturday Night

Tryin’ to wipe out every trace
Of all the other days in the week
You know that this’ll be the Saturday you’re reachin’ your peak

from “(Looking for) The Heart of Saturday Night” by Tom Waits

Thank you

I’d like to thank those who have read the blog over the past year (and beyond). Special thanks go to those who

• subscribe to the RSS feed
• subscribe via email
• follow us on twitter
• have made comments

All the best in the coming year.