Reports of the death of mean reversion are premature This was originally written for the FT, but they seem to have gone the same way as so much media and are dumbed down these days - they said it was too technical after sitting on it for more than a week. Investing based on mean reversion will be less compelling II. Tail hedging becomes more important IV. Historical benchmarks and correlations will be challenged V. Less credit will be available to sustain leverage and high valuations Implications IV and V seem pretty reasonable to me. However, reports of the death of mean reversion are premature.
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Reports of the death of mean reversion are premature This was originally written for the FT, but they seem to have gone the same way as so much media and are dumbed down these days - they said it was too technical after sitting on it for more than a week. Investing based on mean reversion will be less compelling II.
Tail hedging becomes more important IV. Historical benchmarks and correlations will be challenged V. Less credit will be available to sustain leverage and high valuations Implications IV and V seem pretty reasonable to me.
However, reports of the death of mean reversion are premature. I fear that the authors are confusing the distribution of economic outcomes with the distribution of asset market returns. The distribution of economic outcomes may well turn out to be flatter, with fatter tails than we have previously experienced. However, asset markets have long suffered such a distribution; it has proved no impediment to mean reversion based strategies. In fact, the fat tails of the asset market have provided the best opportunities for mean reversion strategies.
As long as markets continue to follow the second implication as they have done since time immemorial and flip flop between irrational exuberance and the depths of despair, then mean reversion at least in valuations is likely to remain the best strategy for long-term investors. This also highlights the apparently contradictory nature of the first two implications that the authors point out.
As always, investors need to be mindful of the context of their investment decisions. It is always possible that we are standing on the brink of a shift in the level to which asset valuations mean revert. But that has always been the case. Only careful thought and research can work to try to mitigate the dangers posed by this threat.
After all, if investing were both simple and easy, everyone would be doing it. The third implication that tail risk hedging will become more important is and always has been true much like the second implication.
Deutsche Bank is launching a long equity volatility index, while Citi has come up with a tradeable crisis index mixing equity and bond vols, swap spreads and structured credit spreads. However, any consideration of the purchase of insurance should not be divorced from a discussion of the price of the insurance.
Cheap insurance is wonderful, and clearly benefits portfolios in terms of robustness. However, the key word is that the insurance must be cheap or at very worst fair value. Buying expensive insurance is a waste of time. I used to live in Tokyo and was constantly amazed that the day after an earth tremor the cost of earthquake insurance would soar, as would the demand!
You should really only want insurance when it is cheap, as this is the time when no one else wants it, and perversely the events are most likely. Buying expensive insurance is just like buying any other overpriced asset Rather than wasting money on expensive insurance, holding a larger cash balance makes sense. It preserves your dry powder for times when you want to deploy capital, and limits the downside.
As Buffett said, holding cash is painful, but not as painful as doing something stupid! In essence, many of the implications are less the new normal, and more the old always!
MiB: James Montier, GMO
For many investment professionals James Montier is behavioural finance. Its largely through Montier that concepts like anchoring, hindsight bias, herding etc. Too few read books, instead the source of information is papers from investment banks. Hence there is a need for a bridge between theoretical advances and investment practitioners. For behavioural finance Montier has been this bridge and a whole generation of investment professionals is wiser as a result. This is Montiers second book. The first one builds on a number of lectures in behavioural finance held as a visiting professor at university.
BEHAVIOURAL INVESTING JAMES MONTIER PDF
The content is practitioner focused throughout and will be essential reading for any investment professional looking to improve their investing behaviour to maximise returns. Overconfidence as a Driver of Poor Forecasting. Here, editorial work has consisted of writing a short preface and collating the original bibliographies. You can also follow us on FacebookTwitter and LinkedIn. Behavioural investing seeks to bridge the gap between psychologyand investing.