Research Paper

Wonder if I bragged about this here... After a long time, I was browsing through WIMWI website and found the following interview in a newsletter. Something somewhere sounded vaguely familiar... Oops this was the project I had done 3 years back! Its already THREE full years now??? Wonder if anyone not so familiar with portfolio allocation (for that matter, even the ones who are familiar with it) will understand the following interview, leave alone the original research paper. The project report looks like its worth 28$ a copy! I have no clue where the money goes - that is if somebody takes the pain to buy a copy!!! So apart from adding 4+ GPA to my CGPA, the work has added more value to me and the world (hopefully ;-) Over to the interview now...

Portfolio Allocation: Beyond Mean Variance

Professor Arnab Laha

Q Arnab, you have moved away, or if I may say, dared to think beyond Markowitz, a Nobel Prize laureate. Where and how does your work differ from that of Markowitz?

A Markowitz’s mean-variance framework assumes that returns on the stocks constituting a portfolio have finite mean and variance. It has been known for quite some time that some stocks do not obey this requirement. In such situations one cannot obtain the optimal portfolio using Markowitz’s approach. Our paper discusses portfolio allocation when some stocks (or assets) in the portfolio do not have finite expectation and variance.

Q What are the benefits of your model vis-a-vis Markowitz’s model?

A Our model is more general than that of Markowitz and can be applied to obtain optimal allocations for any portfolio and makes no demand that the returns on the stocks in the portfolio have finite expectation and variance.

Q What is the new criterion developed by you to take care of stocks which show “heavy-tailed distribution”? Arnab, as I am using a technical term from your paper, can you please explain in simple terms the meaning of these terms.

A The term “heavy-tailed distributions” refers to distributions for which we have higher chances of obtaining extreme values (high or low) than that would be expected for a normal distribution. There are a large number of distributions which are heavy-tailed, of which, some do not even have finite expectation and variance. We develop new criteria for portfolio optimization which are applicable for any type of return distribution.

Q Can an investor use this model? What are the benefits?

A Yes, investors can use this model to their benefit. The results in this paper show that if the returns of one or more of the stocks in a portfolio are heavy-tailed, then the portfolio allocation done by our method performs much better than the portfolio allocation obtained by a naïve application of the mean-variance method.

Q Can your model account for the recent crash in the share market? If yes, why and if not, why not?

A No, ours is not a market model and hence it is not expected that it will be able to predict market crashes. However, the results in the paper show that an investor may be better protected if they do portfolio allocation using our method than the mean-variance method.

Laha, A K; Bhowmick, D and Subramaniam, B (2007). “Portfolio Allocation with Heavy-Tailed Returns,” Applied Financial Economics Letters, 3(4), 237-42.

You can click here for the paper and here for the interview !

~*~ Bhars

P.S: Also, this becomes the 150th post in 4 years now! Lets see how and where it goes!!! Bbye!

Mothers' day...

Just read the article and I am really moved by what Thomas Friedman writes about his mom in NYTimes....

I don’t recall her ever uttering a word of cynicism. She was not naïve. She had taken her knocks. But every time life knocked her down, she got up, dusted herself off and kept on marching forward, motivated by the saying that pessimists are usually right, optimists are usually wrong, but most great changes were made by optimists.

I do not believe in these special days like mothers day, fathers day, valentines day and the like. (Well I prefer holidays though ;-). But know what, I did call my mom yesterday - just like any other day. In fact, I called her twice (the second call was to ask what to do with the left over sugar syrup after cooking gulab jamuns ;-). In fact I didn't even know yesterday was mothers' day. I wonder if she knew it as well. Hmm... should I call her up and say "He he he mom... you know what belated happy mothers day and ya I love you :D" I am sure she is gonna say 'Podi naaye phona vayiii!' duh!

I was a jerk when it comes to my relationship with my mom (may be I was that dad's girl)! I never managed to win her love as dramatically as my sister did. The cry baby nitpicking teenager I was, I promptly complained to her she doesn't love me at all... She had one sentence to answer for all my loooooong sessions of cribs. That was 'You will not understand it today, the day will come when you will!'

Ever since I was away from home, I missed her. Ever since I had a home for myself, in the past 3 months, not a day passed by without silently acknowledging what she had done for me all life. I think she must be smiling secretly in Thanjavur knowing that I am realizing it all everyday! May be she even knows what are the further lessons that await.

I wonder if there are ways to give back to parents... How much ever we account for, these remain irrepayable debts... One generation can at the max loan to the next, may be...

God bless moms!

~*~ Bharsss