Sebastien Lleo is Associate Professor of Finance at NEOMA Business School (France)
Analyst views and expert opinions matter. They are an invaluable complement to market data when it comes to formulating relevant capital market expectations and to strengthening risk management models and practices. But watch out for behavioral biases!
“Garbage in – garbage out!” Every investment management professional has heard the warning that poorly formulated capital market expectations will get portfolio optimisers to produce inefficient, unrealistic, and even outright dangerous portfolios.
Thus, considerable efforts have taken place to turn available economic and market data into accurate capital market expectations. These lead to the development of slick statistical methods, effective econometric techniques, and powerful machine learning algorithms.
Opinions can also be an invaluable source of insights to construct accurate capital market expectations.
What are the types of opinions on financial markets?
Opinions take multiple forms in financial markets. They include analyst views, opinions from political and economic experts, super forecaster predictions, and investor polls.
Moreover, opinions abound on financial markets. Consultancy Quinlan & Associates reported that the bigger banks and brokerages emailed over 40,000 pieces of research every week in 2016, despite continuing job cuts in the financial sector. Social media also contribute to the spread of opinions: according to the financial website Modestmoney.com, there are at least 839 active financial blogs published in English.
Why should I use expert opinions?
Opinions have three key benefits.
First, opinions can be a crucial complement to traditional economic, corporate and financial market data to construct realistic capital market expectation, and keep those up-to-date. This statement is especially true in times of heightened uncertainty, such as market bubbles and financial crises, when traditional data fail to provide an accurate assessment of market conditions.
Second, opinions can strengthen risk management models and practices. Opinions can widen the range of scenarios considered in portfolio optimisation and risk management. Dissenting opinions provide a cornerstone for the construction of meaningful stress test scenarios.
Third, we can use opinions, even when traditional data are not. For example, assessors evaluate insurance claims, and appraisers estimate the value of illiquid assets, such as real estate and collectables, periodically.
How easy is it to collect opinions?
The inclusion of opinions requires extreme care.
Let’s look at analyst views and expert opinions. We all know that not all experts or forecasters are equally accurate. A widely reported study by CXO Advisory Group LLC tracked 6,582 forecasts for the U.S. stock market published by 68 experts between 2005 and 2012. The study found that average accuracy across experts was 47.4%, with individual accuracies ranging from a low of 21% to a high of 68%.
Therefore, investment management teams need to implement a process to guarantee the relevance of the opinions used in their models. This process, known as “elicitation,” is described in abundant literature. The books by O’Haghan (2006) and by Meyer and Booker (2001) are an excellent place to start. Essentially, the elicitation process helps to construct views that are specific, explicit, and structured. Opinions need to focus on a specific variable or parameter, such as the price of a given asset or the mean of a distribution. Opinions need to explicitly provide a mid-point or most-likely scenario, a confidence interval, and to relate the confidence interval to a probability distribution. Finally, opinions need to be structured to provide a transparent and auditable trail.
What are the implementation challenges?
Three main implementation challenges need addressing.
The first and most dangerous challenge is that opinions are often subject to the behavioral biases. Behavioral biases, in particular overconfidence, excessive optimism, conservatism, confirmation bias, and groupthink play an essential role in how finance professionals perceive and process information, and on how they form their forecasts. Recently, in a simulation study, Davis and Lleo (2020) recently found that the presence of biases explained nearly 70% of excess risk-taking. Therefore, it is crucial to debias forecasts before using them in any model.
Second, expert opinion models are Bayesian and therefore require the specification of a prior distribution. We can overcome this difficulty with some original thinking, as with Black and Litterman’ reverse optimisation exemplifies.
Third, aggregating of multiple expert opinions is considered an essential conceptual and computational problem because it requires engineering a joint distribution out of a collection of univariate distributions.
How can I integrate opinions in my portfolio selection model?
Currently, several families of portfolio selection models use opinions as input. The best-known and oldest is the Black and Litterman (1992) model, which uses analyst views to generate capital market expectations in a Markowitz-style single-period optimisation framework. This approach has been extensively discussed and developed in a large number of subsequent papers and chapters.
However, the Black-Litterman approach has two fundamental limitations. First, it is static, meaning that it locks portfolio managers into a “buy-and-hold” strategy, ignoring the possibility that portfolio managers may shift their asset allocation as financial market conditions change. Second, it ignores the presence of behavioral biases in expert opinions.
To address the first limitation, Frey et al. (2012) and Davis and Lleo (2013,2020) proposed two closely-related dynamic portfolio management models. Although both models are developed in continuous time, we can transpose them to a multiperiod discrete-time setting.
The second limitation has proved more elusive. At the moment, Davis and Lleo (2020) is the only dynamic portfolio selection model that addresses for behavioral biases.
Black, F., Litterman, R., 1992. Global portfolio optimisation. Financial Analyst Journal 48 (5), 28–43. Davis, M., Lleo, S., 2013. Black-Litterman in continuous time: the case for filtering. Quantitative Finance Letters. 1 (1), 30–35.
Davis, M., Lleo, S., 2020, Debiased expert forecasts in continuous-time asset allocation. Journal of Banking and Finance. 113.
Frey, R., Gabih, A., Wunderlich, R., 2012. Portfolio optimisation under partial information with expert opinions. International Journal of Theoretical and Applied Finance 15 (1). O’Hagan, A., 2006. Uncertain Judgments: Eliciting Expert’s Probabilities. Wiley.
Meyer, M., Booker, J., 2001. Eliciting and analysing expert judgment: a practical guide. ASA-SIAM Series on Statistics and Applied Probability. Society for Industrial and Applied Mathematics.
STOP THE CONFUSION: HOW TO KNOW IF YOUR BUSINESS MAY BE INSURED AGAINST COVID-19
By Alex Balcombe, Partner at Harris Balcombe
The last few weeks has seen businesses in hospitality, tourism, retail, leisure and more forced to close their doors following the Government’s orders that they should close to prevent the spread of coronavirus.
While this is expected to flatten the curve and reduce the number of coronavirus cases, it will of course have an impact on businesses and employees alike. For small businesses especially, there are many concerns about how they can claim on their insurance to weigh the fall of this impact.
In response to calls to help struggling businesses, the Government has informed the public that companies who are facing turmoil will be able to claim on their business interruption insurance during this difficult time. For most, this is wrong.
The insurance industry has also been extremely vocal that there is no cover for any coronavirus-hit businesses during this tough financial period. This isn’t strictly true either.
How can businesses see through the mixed messaging and best secure their future and their livelihoods and reduce money worries? It’s an extremely stressful time for many companies, and confusion over whether or not they can be covered can only cause more unnecessary stress.
Since it’s a new disease, most businesses will not be covered for business interruption due to COVID-19. In fact, the vast majority of policies do not cover anything related to COVID-19.
That said – don’t rule out the idea that you may be covered. There is a chance that you will be covered against COVID-19, but not know it. This is a very small chance, but your current cover may already protect your business against the consequences of coronavirus, and the nationwide response to it – though those with this cover are unlikely to realise it.
How Could I Be Covered?
Not everyone has business interruption insurance, as it’s not a legal requirement. It is entirely up to the policy holder to weigh up the benefits of having it, and their ability to trade should a disaster happen.
To be considered for cover for COVID-19, there are two types of policy extensions to your business interruption cover that can potentially cover you for this situation:
Infectious Disease Extension
Many policies expressly state which diseases fall within the realm of being an infectious or notifiable disease. If this is the case, your policy will not provide cover. As it is a new disease, these policies will not have included COVID-19.
Other infectious disease extension policies will define the disease with reference to the actions of the government. Since the UK Government has named COVID-19 as a notifiable disease throughout the UK, it is possible that your business may fall into this definition, thus meaning you may be able to make a claim.
However, again, it’s not always that simple. Many policies require the disease to have been on your premises, while others specify a radius from your premises in order to qualify.
Denial of Access Extension (non-damage)
Denial of Access Extension (non-damage) policies may cover you if you’re prevented from accessing your property. This could be due to an event, or by the actions of a competent authority, which could cause your business interruption cover to engage.
If covered by this clause, there are often very subtle differences in wording in your policy. This could depend on the insurer or policy. You may well be covered, but it will depend on your particular circumstances, and the specific policy wording.
It’s clear that the Government needs to do more in ensuring there is clear messaging for businesses, and to help the insurance market look after policy holders. This is an unprecedented situation, and with many people looking to claim on their insurance, we’re already seeing major delays which could have a domino impact.
People throughout the world are understandably facing all kinds of worries because of the current pandemic. Our ways of living have changed, and many business owners will not have experienced a situation like this in their life times. If you own a business and are unsure about whether you can claim for business interruption, or are confused about ambiguous wording, get in touch with a loss assessor.
These claims are not simple, but loss assessors will be experts in business interruption insurance, and will specialise in large and complex claims. They will be able to help and guide you along the way, check your wording and work on your behalf to make sure you get everything you are entitled to.
HERE’S HOW YOU CAN LEARN TO TRADE RISK-FREE DURING THE COVID-19 MARKET CRASH
Trading app BullBear has launched new features to support budding investors looking to hone their skills against the backdrop of the COVID-19 stock market plunge. The risk-free financial game aims to empower the next generation of investors to learn how to trade stocks and shares by playing with dummy chips as opposed to real money. The app updates come as investors pull back from a volatile stock market rocked by the coronavirus outbreak.
At a time when some fresher investors are experiencing their first-ever stock market crash and seasoned investors are reluctant to invest new capital in the market, BullBear is empowering a whole new cohort of traders by teaching them how to trade effectively at no risk.
App users can engage in both short-term and long-term trading games using real-time market data from popular stocks enabling them to build investing confidence, making the app both engaging and educative.
With over 35,000 downloads, the app provides a free, fun way for thousands to learn how trading works by offering a practice arena in which trades take place and where no real money can be lost. Users can also enter into duals and competitions with other players. Whilst the app incorporates dummy chips to invest with, players can still redeem prizes by winning ‘bulls’ when they rank high in games. These bulls can be used to redeem rewards, such as gift cards from retailers like Amazon, Apple, Google Play and Netflix, at the in-app store.
Co-founder of the BullBear app, Anurag Saboo, stated
“I realised just how lacking the support for young investors was when my cofounder and I wanted to invest some money in stocks whilst at university. We had no idea where to start and so spent a couple of months trying to find a platform through which we could learn the basics before we risked any cash. But it simply didn’t exist. The resources that did were dull and theoretical. Paper trading can be very boring, and no-commission trading helps only if you make money out of your portfolio. Social methods of learning can help, for example, Etoro’s copy trades, but they still don’t let investors explore the markets themselves before putting money down. Combine this with the fact that only a small percentage of young investors make money through the market, and others end up staying away or are pushed away through losses, we decided to launch BullBear to offer a free, fun alternative.”
During a time of crisis accompanied by a turbulent stock market, the BullBear app provides a fail-proof way for budding investors to develop their trading knowledge, helping them to make more informed investments.
The BullBear app is available to download now on Google Play and the App Store.
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