By Terence Chabe, Business Development Manager, Colt Capital Markets
The dwindling game of improving speeds
Increasing the speed of trading has long been an obsession for capital market firms. To put it bluntly, the faster the rate a firm runs at equates to more potentially completed trades. Looking back in the capital markets, firms favoured traders who were physically quick on the phone, and this notion is replicated today with firms who speed up trading systems to gain a competitive advantage over rivals.
This pursuit of speed in modern times has seen substantial investments made into state-of-the-art low latency infrastructure. This infrastructure has become so advanced, in fact, that latency speeds are continuing to grow closer to as fast as physically possible, with some systems now completing trades in milliseconds.
Speed has been, and always will be, important in the capital markets. Increasingly though, being fast is becoming less and less of a competitive differentiator for firms and more of a general expectation of any modern market player. The competitive advantages speed once offered are increasingly instead being offered by a new pursuit of smart technologies.
Today’s market is centred around market data and intelligence, this means embracing modern technologies will be a key part of being a successful market player going forward. Cloud computing, artificial intelligence (AI) and machine learning solutions are all offering market participants the chance to infer new meaning from data and automate decisions in ways smarter than ever before. It’s an opportunity that no firm should be missing.
Harnessing the true potential of big data
A year on from the MiFID II regulation coming into effect and data has never been as big of a topic in the capital markets. Firms must now produce, and then store, huge amounts of data to comply with the new regulatory standards. Some have bemoaned this fact, but more sharp players have seen the value in utilizing this vast amount of data. This isn’t to say that MiFID II compliance has made more data available, the data has been there for years, but previous analytics weren’t able to properly handle and analyse it. AI solutions have changed this and can do more with data than ever possible before.
AI solutions can be utilised today to provide advanced macro research, analysing thousands of securities in real time to provide insights into the value and risk of a stock, as well to make recommendations on overall investment strategies. This an example of an AI solution augmenting the actual intelligence of traders. As well augmenting intelligence, AI can also augment a trader’s overall decision making. Products with Analytics-as-a-service features helps traders have a strong grasp on the data they’re using, with tick data and alternative data sets pulled out to give traders the hard statistics needed to base improved decision making upon.
It’s also worth noting that AI solutions can potentially be very cost effective for firms. Before, firms were forced to pay quantitative analysts to examine data in a manual way. AI technologies are increasingly displaying that they can disrupt this traditional reliance on expensive human analysts through providing a cheaper, faster and automated service.
Lessons to be learnt from other sectors
AI solutions and products are already fairly established in the capital markets and should grow more and more popular in adoption. For the savviest of firms in the market, who really want to embrace smart technologies, an examination of how cutting-edge technologies are being used within other sectors is in order.
In the retail sector, chat bots have been implemented by businesses to help improve both customer experience and the overall digital experience offered. Chat bots are becoming so advanced that some retailers are now implementing them on social media channels, where bots can have instant messaging conversations with customers in seamless real time.
As chatbots grow in prominence in other sectors, it will become difficult for those in capital markets to ignore the benefits that they can bring. Just imagine how a chatbot could transform the trading process, with an automated agent one day potentially being able to complete a trade for a buyer without the need for a human trader at all. In this context, it’s evident that chatbots have the potential to totally transform how trading is done in the capital markets, this is something that should be on the radar of every firm.
Changing before its too late
The pursuit of continuingly improved speeds in the capital markets has become a very deep-rooted fixation, and that’s understandable. Speed will always be important, but for firms to truly gain a competitive advantage today high latency speeds must be partnered with technologies that are increasingly showing their potential to transform the capital markets.
This coupling of low latency speeds and new technologies will be the blueprint of success for capital market players going forward, those firms that choose to ignore the huge potential of AI and machine learning do so at their own risk.
TWO TO TANGO? MARKET DATA AND OPINIONS IN INVESTMENT MANAGEMENT
Sebastien Lleo is Associate Professor of Finance and Head of the MSc in Risk and Financial Technologies 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.
AN ULTIMATE GUIDE TO TURNING YOUR EARLY RETIREMENT DREAM INTO A REALITY
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ.
This article is for all those who are counting their IRAs, 401 (k), self-directed 401k and other retirement planning options to enjoy that late-life freedom as early as 45 or 40. Financial freedom at 55 has become a thing of the past because today it all depends on your ability to take the right decisions. If your 9 to 5 life has left you drained and you are serious about an early retirement, here are 8 ways to coach you from scratch:
- Free yourself from the vicious circle of debt
The first step to securing an early retirement is getting yourself free from debt. If you do not wish to enter your early retirement with any financial lags or large payments that can eat away a massive chunk of your modest savings, you need to increase your cash flow by clearing all your debts. Paying off your mortgage or lease early will help you divert the funds into a Roth IRA or other retirement savings.
- Start living a frugal life
Saving is the only way to increase the cash flow as your career progresses and this can be done by controlling your expenses. It does not mean giving up on all your desires but only requires you to live a frugal lifestyle. A few compromises and you can save a significant amount which will eventually bring you closer to your early retirement dream. From giving up on your expensive memberships and cutting down your HVAC usage to making a few compromises in your lifestyle and sacrificing a few golf games, your day-to-day frugal acts will free you from your cubicle and give you the freedom to retire early.
- Be open to the idea of changing
Prioritize between your wants and your needs. This will help you break free from the shackles of your tiring nine to five schedule. Enjoying life to the fullest sounds like a great idea to most of us, but it also means that you are losing on the real joy of retiring at 40 for momentary happiness. If fancy dinners and long drives in luxury cars mean more to you, an early retirement is obviously out of your reach. Mindful spending needs major lifestyle changes for which you may need to give up on stylish clothing, lavish parties, exotic vacations and more. This is only possible if you change your perception of conventional societal programming which demands that you give up on your desires of bigger houses and new cars. It calls for a complete mind shift from spending to saving.
- Take a head start with a high-paying industry
It is possible to retire well before you turn 60 if you are working for an industry that pays really well right from the start. A good-paying job plays a critical role in paving your path to a financially independent future. You too can enjoy a retirement of rest and relaxation if you are willing to take up personal responsibility in professional life. Getting closer to your goal of early retirement requires you to be self-sufficient early on in life.
- Automate 50% of Your Annual Income to Retirement Savings
Allocate as high a percentage of your annual income as possible to pay up your previous debts, pending bills, leases, and loans. Once you are done with of all these, automate your income towards retirement savings. You can start with 30% and raise the bar every year as your income increases. Every time you get a raise, increase the amount you add to your retirement reserve.
- Be sure to invest in a 401 (k) plan
Many employers are offering 401 (k) plans where you can invest a certain amount of your income and your employer makes a matching contribution to bolster your retirement savings.
- Stick to a frugal lifestyle
You need to revamp your investment plan as your career keeps progressing. What you want to achieve – an early retirement is an extraordinary goal and so your efforts should be focused on living frugally. Always keep a rewarding retirement at the top of your mind and you will remain motivated to keep the passion alive and pursuit kicking.
- Invest in an IRA
An IRA is a preferred and popular choice for retirement savings. You can consult an experienced and reputed financial advisor to guide you in selecting right IRA. An IRA will allow you to enjoy tax benefits if you choose to retire early. It will get to where you want faster than you think.
Start investing right away and make your retirement the best phase of your life.
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