scholarly journals Asset Allocation and Security Selection in Theory & in Practice: A Literature Survey from a Practitioner’s Perspective

2015 ◽  
Vol 1 (2) ◽  
pp. 10
Author(s):  
Hany Fahmy
Keyword(s):  
Financial Markets ◽  
Behavioral Finance ◽  
Asset Allocation ◽  
Investment Strategy ◽  
Price Formation ◽  
Series Data ◽  
Portfolio Construction ◽  
Efficient Markets ◽  
Financial Assets ◽  
Finance Industry

Whether for the sake of trying to make a fortune or for the sake of knowledge, both practitioners and academicians have had interests in studying the behavior of financial time series data since the existence of financial markets. Academicians contributed equilibrium models that aim to describe the process of price formation in capital markets. Over time, two schools of thoughts were established: the efficient markets school and the behavioral finance school. Proponents of the former believed in the Efficient Markets Hypothesis (EMH), whereas the latter brought evidence from behavioral finance and neurosciences showing that investors, especially retail traders, exhibit irrational behavior, which can explain the observed violations of the EMH in financial markets. Practitioners were not interested in developing models of price formation; rather they were interested in developing techniques to analyze and predict the price movements of financial assets. Same as academicians, practitioners can also be grouped into two schools of thought: the fundamental analysis school and the technical analysis school. Although both schools of thought share the same objective, which is to give advice on what and when to buy and sell assets for the sake of making profit, they differ in their ways of analysis. The significant role played by academicians and practitioners in the finance industry and the interconnection between both schools and the approaches followed within each of them are best perceived in the way financial assets are allocated and portfolios are constructed. In an attempt to cross that bridge between the theory of price formation in financial markets and its practical implementations, this paper aims to survey the literature on both the theoretical and the practical frontiers of asset allocation and portfolio construction, and the best way of carrying on this task is through a thorough description of the portfolio management process (PMP). To this end, the paper breaks the PMP into three main steps, namely, portfolio planning, portfolio construction, and portfolio evaluation, in that order, and then discusses each step while surveying the literature pertaining to it. In addition to the description of the PMP, the paper also answers questions of particular interest to young practitioners, who are taking their first steps towards a career in the finance industry, such as: How portfolio theory, which is at the core of finance theory, is applied in practice? How a financial portfolio of assets is constructed in practice? How the individual assets forming a portfolio are selected and allocated? And is the process of constructing portfolios unique? Although the answers to these questions might appear to be simple and straightforward, they are, in fact, quite complicated. The complication lies not only in making the theory, which is based on certain restrictive and unrealistic assumptions, work in practice, but also in the simultaneous use of a variety of tools and financial concepts in forming a sound investment strategy.

scholarly journals Testing the Empirical Validity of the Adaptive Markets Hypothesis

2017 ◽  
Vol 9 (2) ◽  
pp. 169-184
Author(s):  
Hany Fahmy
Keyword(s):  
Financial Markets ◽  
Behavioral Finance ◽  
Asset Allocation ◽  
Smooth Transition ◽  
Efficient Markets ◽  
Irrational Behavior ◽  
Smooth Transition Regression ◽  
Efficient Markets Hypothesis ◽  
Smooth Transition Regression Model ◽  
Over Time

The issue of market e¢ ciency attracted the attention of academicians since the existence of financial markets. Over time, two schools of thoughts were established: the efficient markets school and the behavioral finance school. Proponents of the former believed in the Efficient Markets Hypothesis whereas the latter brought evidence from behavioral finance and psychology to demonstrate that financial markets are inefficient and this inefficiency is attributed to the irrational behavior of investors in making financial choices regarding asset allocation and portfolio construction. Recently, an adaptive reconciliation was suggested, which posits that investors'adaptability is what brings back inefficient markets to efficiency. The purpose of this paper is to test empirically the validity of the Adaptive Markets Hypothesis via a smooth transition regression model with exogenous threshold variable. The results support the reconciliation and show that markets are indeed efficient sometimes and inefficient most of the time.

EFFICIENT MARKETS AND BEHAVIORAL FINANCE: A COMPREHENSIVE MULTIFRACTIONAL MODEL

2015 ◽  
Vol 18 (01n02) ◽  
pp. 1550001 ◽  
Author(s):  
SERGIO BIANCHI ◽  
ALEXANDRE PANTANELLA ◽  
AUGUSTO PIANESE
Keyword(s):  
Stochastic Model ◽  
Financial Markets ◽  
Financial Market ◽  
Behavioral Finance ◽  
Real World ◽  
Efficient Market Hypothesis ◽  
Efficient Markets ◽  
Living Matter ◽  
Psychological Phenomena ◽  
Special Cases

Real-world financial dynamics daily do challenge the credibility of the Efficient Market Hypothesis, the pillar of the whole martingale-based modern financial theory stating that at any time asset prices discount all past information. As a matter of fact, the empirical evidence accumulated so far indicates that current models cannot explain the complexity of financial market movements, to the extent that a strand of skeptical thought, the Behavioral Finance, has been booming. The question whether a model exists which is able to make consistent the two paradigms is a living matter that financial markets demand to address. The paper deals with a parsimonious stochastic model able to include as special cases both market efficiency and "psychological" phenomena such as the underreaction and the overreaction, peculiar features of the behavioral finance. The great readability of the model, its capability to agree the controversial results provided by literature on efficient markets and the simplicity of the financial intuition it offers are discussed.

scholarly journals Behavioral biases in pension fund trustees’ decision making

2019 ◽  
Vol 11 (2) ◽  
pp. 128-143
Author(s):  
Leonardo Weiss-Cohen ◽  
Peter Ayton ◽  
Iain Clacher ◽  
Volker Thoma
Keyword(s):  
Decision Making ◽  
Financial Markets ◽  
Behavioral Finance ◽  
Asset Allocation ◽  
Institutional Investors ◽  
Pension Fund ◽  
Content Type ◽  
Behavioral Biases ◽  
The Past ◽  
State Of Affairs

PurposeBehavioral finance research has almost exclusively investigated the decision making of lay individuals, mostly ignoring more sophisticated institutional investors. The purpose of this paper is to better understand the relatively unexplored field of investment decisions made by pension fund trustees, an important subset of institutional investors, and identify future avenues of further exploration.Design/methodology/approachThis paper starts by setting out the landscape in which pension fund trustees operate and make their decisions, followed by a literature review of the extant behavioral finance research applicable to similar situations.FindingsDespite receiving training and accumulating experience in financial markets, these are limited and sparse; therefore, pension fund trustees are unlikely to be immune from behavioral biases. Trustees make decisions in groups, are heavily reliant on advice and make decisions on behalf of others. Research in those areas has uncovered many inefficiencies. It is still unknown how this specific context can affect the psychological effects on their decisions.Research limitations/implicationsGiven how much influence trustees’ decisions have on asset allocation and by extension in financial markets, this is a surprising state of affairs. Research in behavioral finance has had a marked influence on policy in the past and so we anticipate that exploring the decisions made within pension funds may have wide ramifications for the industry.Originality/valueAs far as the authors are aware, no behavioral research has empirically tested pension fund trustees’ decisions to investigate how the combination of group decisions, advice and surrogacy influence their decisions and, ultimately, the sustainability of our pensions.

scholarly journals Valuing Peace: The Effects of Financial Market Exposure on Votes and Political Attitudes

Econometrica ◽  
2019 ◽  
Vol 87 (5) ◽  
pp. 1561-1588 ◽  
Author(s):  
Saumitra Jha ◽  
Moses Shayo
Keyword(s):  
Financial Markets ◽  
Financial Market ◽  
Political Attitudes ◽  
Peace Process ◽  
Superior Performance ◽  
Financial Assets ◽  
Material Incentive ◽  
Nonfinancial Information ◽  
Political Messages ◽  
Economic Risks

Can participation in financial markets lead individuals to reevaluate the costs of conflict, change their political attitudes, and even their votes? Prior to the 2015 Israeli elections, we randomly assigned Palestinian and Israeli financial assets to likely voters and incentivized them to actively trade for up to 7 weeks. No political messages or nonfinancial information were included. The treatment systematically shifted vote choices toward parties more supportive of the peace process. This effect is not due to a direct material incentive to vote a particular way. Rather, the treatment reduces opposition to concessions for peace and changes awareness of the broader economic risks of conflict. While participants who were assigned Palestinian assets are more likely to associate their assets' performance with peace, they are less engaged in the experiment. Combined with the superior performance of Israeli stocks during the study period, the ultimate effects of Israeli and Palestinian assets are similar.

scholarly journals Implicit incentives for fund managers with partial information

2021 ◽  
Author(s):  
Flavio Angelini ◽  
Katia Colaneri ◽  
Stefano Herzel ◽  
Marco Nicolosi
Keyword(s):  
Asset Allocation ◽  
Partial Information ◽  
Market Price ◽  
Investment Strategy ◽  
Expected Returns ◽  
Martingale Method ◽  
Fund Manager ◽  
Market Price Of Risk ◽  
Fund Managers ◽  
Price Of Risk

AbstractWe study the optimal asset allocation problem for a fund manager whose compensation depends on the performance of her portfolio with respect to a benchmark. The objective of the manager is to maximise the expected utility of her final wealth. The manager observes the prices but not the values of the market price of risk that drives the expected returns. Estimates of the market price of risk get more precise as more observations are available. We formulate the problem as an optimization under partial information. The particular structure of the incentives makes the objective function not concave. Therefore, we solve the problem by combining the martingale method and a concavification procedure and we obtain the optimal wealth and the investment strategy. A numerical example shows the effect of learning on the optimal strategy.

Heuristic biases in investment decision-making and perceived market efficiency

2018 ◽  
Vol 10 (1) ◽  
pp. 85-110 ◽  
Author(s):  
Syed Zulfiqar Ali Shah ◽  
Maqsood Ahmad ◽  
Faisal Mahmood
Keyword(s):  
Financial Markets ◽  
Market Efficiency ◽  
Negative Impact ◽  
Investment Decisions ◽  
Sampling Technique ◽  
Investment Strategy ◽  
Individual Investors ◽  
Content Type ◽  
Specific Investment ◽  
The Relationship

Purpose This paper aims to clarify the mechanism by which heuristics influences the investment decisions of individual investors, actively trading on the Pakistan Stock Exchange (PSX), and the perceived efficiency of the market. Most studies focus on well-developed financial markets and very little is known about investors’ behaviour in less developed financial markets or emerging markets. The present study contributes to filling this gap in the literature. Design/methodology/approach Investors’ heuristic biases have been measured using a questionnaire, containing numerous items, including indicators of speculators, investment decisions and perceived market efficiency variables. The sample consists of 143 investors trading on the PSX. A convenient, purposively sampling technique was used for data collection. To examine the relationship between heuristic biases, investment decisions and perceived market efficiency, hypotheses were tested by using correlation and regression analysis. Findings The paper provides empirical insights into the relationship of heuristic biases, investment decisions and perceived market efficiency. The results suggest that heuristic biases (overconfidence, representativeness, availability and anchoring) have a markedly negative impact on investment decisions made by individual investors actively trading on the PSX and on perceived market efficiency. Research limitations/implications The primary limitation of the empirical review is the tiny size of the sample. A larger sample would have given more trustworthy results and could have empowered a more extensive scope of investigation. Practical implications The paper encourages investors to avoid relying on heuristics or their feelings when making investments. It provides awareness and understanding of heuristic biases in investment management, which could be very useful for decision makers and professionals in financial institutions, such as portfolio managers and traders in commercial banks, investment banks and mutual funds. This paper helps investors to select better investment tools and avoid repeating expensive errors, which occur due to heuristic biases. They can improve their performance by recognizing their biases and errors of judgment, to which we are all prone, resulting in a more efficient market. So, it is necessary to focus on a specific investment strategy to control “mental mistakes” by investors, due to heuristic biases. Originality/value The current study is the first of its kind, focusing on the link between heuristics, individual investment decisions and perceived market efficiency within the specific context of Pakistan.

scholarly journals Do Cash Holdings Differ in Europe and Asia Pacific?

2019 ◽  
Vol 7 (2) ◽  
pp. 1-32
Author(s):  
Ummar Aftab ◽  
Waseem Akhter Qureshi ◽  
Attiya Yasmin Javid
Keyword(s):  
Financial Markets ◽  
Cash Holdings ◽  
Cash Flows ◽  
Negative Influence ◽  
Asia Pacific ◽  
Cash Holding ◽  
Financial Assets ◽  
Dividend Payment ◽  
Financial Strength ◽  
Cash Reserves

This paper identifies the determinants that contribute towards the variation in financial assets that make up a firm’s total cash reserves, specifically in two important regions of the world i.e. Asia Pacific and Europe. The findings of the research reveal that firms in the region of Asia Pacific have slightly higher cash holdings, as compared to firms in Europe. Moreover, the study also identifies that the elevated cash holdings in Asia Pacific are not a result of the agency problem, as is generally viewed, rather, the shareholder power hypothesis is a more appropriate measure to elucidate this elevation in the level of cash holdings in the region. When shedding light on to the firm specific cash holding determinants, the findings of the research reveal that leverage, dividend payment, profitability, growth and net working capital, cash flows and financial strength, influence cash reserves in both the regions, exactly in the same manner. This shows the application of transaction, and precautionary motives in both the regions. The study further identifies that size, and investments have a varying effect in both the regions that are taken into consideration. Again, this difference may be attributed to Shareholders’ Power Hypothesis, specifically for Asia Pacific and the Agency View, specifically for Europe. Shareholders’ Right Index influences cash reserves in Asia Pacific in a positive manner, while in Europe, the same index shows a negative influence. The development in the financial markets has a negative negatively influence on cash holdings in Asia Pacific, and a positive one in Europe.

scholarly journals FRACTAL MARKETS HYPOTHESIS AND THE GLOBAL FINANCIAL CRISIS: SCALING, INVESTMENT HORIZONS AND LIQUIDITY

2012 ◽  
Vol 15 (06) ◽  
pp. 1250065 ◽  
Author(s):  
LADISLAV KRISTOUFEK
Keyword(s):  
Financial Crisis ◽  
Complex Systems ◽  
Financial Markets ◽  
Global Financial Crisis ◽  
Efficient Markets ◽  
Investment Horizon ◽  
Heterogenous Agents ◽  
Efficient Markets Hypothesis ◽  
The Global Financial Crisis ◽  
Underlying Processes

We investigate whether the fractal markets hypothesis and its focus on liquidity and investment horizons give reasonable predictions about the dynamics of the financial markets during turbulences such as the Global Financial Crisis of late 2000s. Compared to the mainstream efficient markets hypothesis, the fractal markets hypothesis considers the financial markets as complex systems consisting of many heterogenous agents, which are distinguishable mainly with respect to their investment horizon. In the paper, several novel measures of trading activity at different investment horizons are introduced through the scaling of variance of the underlying processes. On the three most liquid US indices — DJI, NASDAQ and S&P500 — we show that the predictions of the fractal markets hypothesis actually fit the observed behavior adequately.

Nexus between Southeast Asian stock markets, bitcoin and gold: spillover effect before and during the COVID-19 pandemic

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Yosuke Kakinuma
Keyword(s):  
Southeast Asia ◽  
Stock Markets ◽  
Spillover Effect ◽  
Spillover Effects ◽  
Southeast Asian ◽  
Series Data ◽  
Financial Assets ◽  
Volatility Spillover ◽  
Content Type ◽  
Asset Classes

Purpose This study aims to provide empirical evidence on the return and volatility spillover effects between Southeast Asian stock markets, bitcoin and gold in the periods before and during the COVID-19 pandemic. The interdependence among different asset classes, the two leading stock markets in Southeast Asia (Singapore and Thailand), bitcoin and gold, is analyzed for diversification opportunities. Design/methodology/approach The vector autoregressive-Baba, Engle, Kraft, and Kroner-generalized autoregressive conditional heteroskedasticity model is used to capture the return and volatility spillover effects between different financial assets. The data cover the period from October 2013 to May 2021. The full period is divided into two sub-sample periods, the pre-pandemic period and the during-pandemic period, to examine whether the financial turbulence caused by COVID-19 affects the interconnectedness between the assets. Findings The stocks in Southeast Asia, bitcoin and gold become more interdependent during the pandemic. During turbulent times, the contagion effect is inevitable regardless of region and asset class. Furthermore, bitcoin does not provide protection for investors in Southeast Asia. The pricing mechanism and technology behind bitcoin are different from common stocks, yet the results indicate the co-movement of bitcoin and the Singaporean and Thai stocks during the crisis. Finally, risk-averse investors should ensure that gold constitutes a significant proportion of their portfolio, approximately 40%–55%. This strategy provides the most effective hedge against risk. Originality/value The mean return and volatility spillover is analyzed between bitcoin, gold and two preeminent stock markets in Southeast Asia. Most prior studies test the spillover effect between the same asset classes such as equities in different regions or different commodities, currencies and cryptocurrencies. Moreover, the time-series data are divided into two groups based on the structural break caused by the COVID-19 pandemic. The findings of this study offer practical implications for risk management and portfolio diversification. Diversification opportunities are becoming scarce as different financial assets witness increasing integration.

Asset Allocation and Portfolio Construction

2011 ◽  
pp. 159-203
Author(s):  
Noël Amenc ◽  
Felix Goltz ◽  
Lionel Martellini ◽  
Vincent Milhau
Keyword(s):  
Asset Allocation ◽  
Portfolio Construction
Sign in / Sign up

Export Citation Format

Share Document