I was bringing my daughter back from Penn State University yesterday for Thanksgiving break and she had my Pi movie
http://www.pithemovie.com/gifpage.html
that I had not seen in some time and seemed to fit right in with the work this morning. I am reviewing the Statistical Arbitrage work of Ed Thorp published by Wimott Magazine. The first 3 parts are pdfs:
- http://www.wilmott.com/pdfs/080617_thorp.pdf
- http://www.wilmott.com/pdfs/080630_thorp.pdf
- http://www.wilmott.com/pdfs/080709_thorp.pdf
Parts 4-6 are Word documents and can be found in the references at
http://en.wikipedia.org/wiki/Statistical_arbitrage
The articles examines the 70s-80s-90s work in this discipline. Here some of his thoughts and I would encourage to read all six parts of the article.
The Middle Game
Part 1:
Stocks with a large trading volume are called "liquid". They calculate a "fair" price for the largest and most traded stocks on both the New York and American Exchanges. Their strategy is based on their prediction buy the underpriced stocks and short the overpriced stocks. Each stock is 2.5 percent of the long portfolio. They limit the short position to 1.5 percent for each stock. Because of their strategy their results are "postively skewed".
There are about 253 trading days per year.
Part 2:
The author reviews the meaning of arbitrage with hypothetical numerical examples.
First example:
"An example might be sellinggold in London at $300 an ounce while at thesame time buying it at, say $290 in New York.Suppose the total cost to finance the deal and toinsure and deliver the New York gold to Londonis $5, leaving a $5 sure profit. That’s an arbitrage in its original usage." -Ed Thorp
They depend on a large number favorable trades to eventually deliver a profit. The basic
question is "How inefficient is the market?" "How can this be exploited to our advantage?" I agree that questions are more important than answers.
The article provides an overview to the historical answer to these questions.
Part 3:
A discussion on the refrigeration of CPUs and risk reduction. In order to control risk, they segregated into industry groups using factor analysis became the STAR model with 55 industry and 13 macroeconomic factors.
Part 4:
The article makes the important point.
"Note that every stock market system is necessarily limited in the amount of money it can use to produce excess returns. One reason is that buying underpriced securities tends to raise the price, reducing or eliminating the mispricing, and selling short overpriced securities tends to reduce the price, once again reducing or eliminating the mispricing. Thus systems for beating the market are limited in size by the impact of their own trading." -Ed Thorp
Part 5:
A discussion on haggling. I like this quote with the reference to 1/8 dollar a share by
"As President Lyndon Johnson once said about congressional spending, a billion dollars
here, a billion dollars there, and pretty soon you’re talking about some real money." -Ed Thorp
Another right on target quote that dovetails with my reading of Kasparov's latest book
"How Life Imitates Chess" is
"It reminded me of my granddaughter Ava, who when asked at the age of two, “What’s happening?”, replied “Nothing’s happening.” My beautiful ideas were rotting on the vine for lack of follow through. It was clear that if I wanted significant research and development we would have to do it 'in house.'" Back to the Pi movie and looking at every detail of the problem asking questions and leaving bread crumbs.
Part 6:
It is all about time..TIME...TIME... The discussion is on the hedge fund business-a statistical arbitrage hedge fund.
The End Game
The days are passing and ideas are percolating. I think back to Kasparov's book and the following quote:
Play the opening like a book,
the middle game like a magician,
and the end game like a machine.-Rudolf Spielmann
and his comments that, the purpose of the opening isn't to just survive the beginning of the game, it is to set the stage for the type of middle game you want to play.
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