wilmott.com

How to make money

Systematic searches for exploitable predictability. How to make money, without making completely random bets. =======================Even if you trade randomly, you can not be wrong all the time.

My two:1) is correlation random, 'sticky,' or stationary (we pretty much know it isn't stationary).If it is more than random, and it isn't stationary, then it has some sort of viscosity. What is that? is it mechanical, like fluid dynamics? or is the viscosity also multi-factor? like chemical reactions or sub-atomic physics?If correlation is 'sticky' then it also probably is linearly or polynomially predictable with a positive probablity. (This is what I think Jim Simons is doing at RenTech).Do copula methods help, or are they mearly obscuring fundamental uncertainty, or worse, not uncertainty, but true raw ignorance?2) what is the true curve of expected returns for risky assets over tau? We keep using normal and lognormal, but historical data indicates fatter tails, so these are (inadequate) approximations. What is the better approximation? And please e-mail it to me now now now.

My favorite (from the world of corporate finance): Why do firms pay cash dividends?

A similar question:What are the most challenging solveable PhD research topics?

Hi reza –Re your suggestion: “closed form for American Put” as an important problem.I worked out the theoretical formal solution to Bermuda/American options in the late 80’s using path integrals. See my book, parts of Ch. 42, 43, and 44:[Book Forum thread “Quantitative Finance and Risk Management: A Physicist's Approach” , Click Here .From a practical standpoint, application of the path integral formalism provides a robust numerical method for calculating Bermudas/American options. See Ch. 44. We used this code in production in the front office and for risk management. It worked well.

Dynamics at different time scales.I believe that one of the most challenging problems for finance today is associated with obtaining better understanding of realistic dynamics for underlying processes (interest rates, stocks, FX, …) at different time scales. This includes short-term dynamics (probably associated with trading) and long-term dynamics (probably associated with macroeconomic effects). Gap-jump behavior is an additional complication.

My two:1) is correlation random, 'sticky,' or stationary (we pretty much know it isn't stationary).If it is more than random, and it isn't stationary, then it has some sort of viscosity. What is that? is it mechanical, like fluid dynamics? or is the viscosity also multi-factor? like chemical reactions or sub-atomic physics?If correlation is 'sticky' then it also probably is linearly or polynomially predictable with a positive probablity. (This is what I think Jim Simons is doing at RenTech).Do copula methods help, or are they mearly obscuring fundamental uncertainty, or worse, not uncertainty, but true raw ignorance?2) what is the true curve of expected returns for risky assets over tau? We keep using normal and lognormal, but historical data indicates fatter tails, so these are (inadequate) approximations. What is the better approximation? And please e-mail it to me now now now. James,I think you're right on! (non-sticky correlation --- predictable, yes, but you gotta do the rotation with a matrix series expansion like JS)Correct again on the sub-atomic physics (actually electon dynamics is equivalent, but use non-ergodic wave mechanics)Sounds like you're now into making money... No more stochastic bull shit.NBTW skicky correlation is related to bond futures.

QuoteOriginally posted by: JamesMy two:1) is correlation random, 'sticky,' or stationary (we pretty much know it isn't stationary).If it is more than random, and it isn't stationary, then it has some sort of viscosity. What is that? is it mechanical, like fluid dynamics? or is the viscosity also multi-factor? like chemical reactions or sub-atomic physics?If correlation is 'sticky' then it also probably is linearly or polynomially predictable with a positive probablity. (This is what I think Jim Simons is doing at RenTech).Do copula methods help, or are they mearly obscuring fundamental uncertainty, or worse, not uncertainty, but true raw ignorance?The interesting thing about correlation is that even in hindsight our estimation of it tends to not be very good in very many financial cases. My view is that the difference between random and sticky correlation is dwarfed by the standard error of measuring correlation, and defining it on a term structure or instantaneous basis. Even when I use a handful of different estimating techniques to get a correlation estimate for pricing a basket option, what I'm doing is little more helpful than licking my thinb and holding it up to the wind when trying to forecast whether it's a good day to go sailing. The good news is that outside the correlation market, that uncertainty often lets me buy correlation at very low levels and sell it at very high levels.Even if correlation were linearly or polynomial predictable, there would be an intensity process for defining the probability of it collapsing away or going to 1 on a sudden event, and that's one of the fascinating things about working with the future and trying to trade it as a term structure.Copula models help like implied volatility in Black-Scholes helps us: it lets us describe the financial world with a simple variable we can move around to see how something is sensitive to it. In doing so, they simplify our work and let us focus on what's important, and separate out what we hope to work on tomorrow. Correlation is probably subject to some form of the Heisenberg uncertainty principle, which means it is not that we are ignorant but that measurement is funamentally limited, and further limited in finance by the assymetry between the future and the past.Somewhere between random/sticky and curious simplicity, I am playing around with a regime-switching correlation model. Anyone else have experiences with this they would like to share?

I propose two unsolved issues:Problem 1We have no model for the relationship between risk and return that is 1) logical, 2) tractable/testable, and 3) empirically reliableThe CAPM succeeded in #1 (subject to its assumptions), but failed in #2 (no realistic way of knowing the market portfolio), and given that it failed in #2, we can't make any statements about #3. Most multi-factor (quasi APT) models succeeded in #2 and maybe somewhat in #3, but failed in #1 because the models are the result of data mining that may bear little relation to future expectations. Problem 2It is impossible to find a broker who can mark a security when you need him. Seriously, these guys must work only 50 days a year.

A consistent measure of risk, basis of all finance problems

For a 'small' but interesting problem on volatility behavior, perfect for a student, see my thread 'Jumps in VIX' in the technical forum. regards,

a) Why do people trade so often (e.g, why is trading volume such as it is)?b) Who uses financial statements as the basis of trading?

How to model liquidity

QuoteOriginally posted by: granchiohere's anothere one, which is the daily bread and butter of many traders:how to price a vanilla 120% one year european call, (or 80% EP, whatever), on a liquid european stock with exitsting but illiquid option market (there are many of those).Please assume that:- there is one dividend expected, but neither date nor amount are officially confirmed-similar instruments trades infrequently, it is sometimes possible to get quotes but they will be say 5 volpoints wide, and for very small size- you either have to quote for a) only bid or ask, but for 10 times the daily volumeb) both side, for 1/3 the daily volume,and you have real political pressure from your bosses to win the trade or at least look good vs the competion, i.e. in (a) you have to be within 1 volpoint of the competition, in (b) you have to be 2 volpoint wide.this is just to point out that our academic work remain focused on the need to fit our volsurfaces to the market, and predict the market smile dynamics, but in reality very often the problem is that there is no such thing as a market.Hello Granchio, I have some naive questions for you. I would hardly find the answers in a paper1- what is a 120% call? is it a moneyness ratio? 2- by 'daily volume' you mean the whole market volume on that option?3- by 'competition' you mean that the client put other banks on the same deal? So you have to stay within 1 volpoint from which price? From the winning one? (i.e. the lowest ask price?) 4- In that case why do your boss want you to win the trade if not capping the 'right' volatility from now to maturity is much more dangerous for your book?5- is there any book or paper wich explains the "operative" option science and trading?Thank's a lot.