Archive for the ‘Investment strategies’ Category

Are our models too complex?

June 17, 2012

Gillian Tett is a well-respected writer for the Financial Times and frequently picks up the topic of complexity in financial markets.

In a recent article (see here) she makes a case that the era of number crunching is over, and that the world of investments is back again firmly in the domain of human relationships and evaluations.

Once upon a time we would measure credit risk with a numbers like survival probability stripped from CDS market prices. Once upon a time we were all happy to value a transaction with models that almost no-one other than the quants understood.

Her view is that these times are gone.

Bond ladders

May 3, 2012

Never heard of bond ladders?

Well neither had I until a few months back. I was running some tests on a sample bond portfolio and discovered a seeming paradox:

A portfolio that is long bonds may actually benefit from a sell off!

The explanation is that you benefit when you reinvest the coupons that your portfolio pays: the bonds you buy are cheaper.

This is a problem of reinvestment risk, and the concept of a bond ladder should be better known as a standard building block for a bond portfolio – it is one way to reduce reinvestment risk.

Here are some articles that give more details: here and here.

Here is an abstract of a more academic pay-per-view paper which discusses bond ladders as a nearly optimal investment strategy.