Financial Modeling of the Equity Market From CAPM to Cointegration

, by Fabozzi, Frank J.; Focardi, Sergio M.; Kolm, Petter N.

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ISBN: 9780471699002 | 0471699004
Cover: Hardcover
Copyright: 1/3/2006

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Summary

Author Biography

Supplemental Materials

In Financial Modeling of the Equity Market, Frank Fabozzi, Sergio Focardi, and Petter Kolm provide you with the tools you need to succeed in managing equity portfolios.

Preface

xiii

Acknowledgments

xvii

About the Authors

xix

CHAPTER 1 Introduction

(12)

Historical Perspective on the Financial Modeling of the Equity Market

(7)

Central Themes of the Book

(1)

Organization of the Book

(4)

PART ONE Portfolio Allocation: Classical Theory and Modern Extensions

(176)

CHAPTER 2 Mean-Variance Analysis and Modern Portfolio Theory

(36)

The Benefits of Diversification

(2)

Mean-Variance Analysis: Overview

(3)

Classical Framework for Mean-Variance Optimization

(12)

The Capital Market Line

(6)

Selection of the Optimal Portfolio When there Is a Risk-Free Asset

(2)

More on Utility Functions: A General Framework for Portfolio Choice

(6)

Summary

(3)

CHAPTER 3 Transaction and Trading Costs

(36)

A Taxonomy of Transaction Costs

(8)

Liquidity and Transaction Costs

(3)

Market Impact Measurements and Empirical Findings

(5)

Forecasting and Modeling Market Impact

(6)

Incorporating Transaction Costs in Asset-Allocation Models

(6)

Optimal Trading

(2)

Integrated Portfolio Management: Beyond Expected Return and Portfolio Risk

(3)

Summary

(2)

CHAPTER 4 Applying the Portfolio Selection Framework in Practice

(28)

Rebalancing in the Mean-Variance Optimization Framework

(12)

Portfolio Constraints Commonly Used in Practice

100

(13)

Summary

113

(2)

CHAPTER 5 Incorporating Higher Moments and Extreme Risk Measures

115

(34)

Dispersion and Downside Measures

116

(15)

Portfolio Selection with Higher Moments through Expansions of Utility

131

(8)

Polynomial Goal Programming for Portfolio Optimization with Higher Moments

139

(2)

Some Remarks on the Estimation of Higher Moments

141

(1)

The Approach of Malevergne and Sornette

142

(5)

Summary

147

(2)

CHAPTER 6 Mathematical and Numerical Optimization

149

(40)

Mathematical Programming

150

(8)

Necessary Conditions for Optimality for Continuous Optimization Problems

158

(1)

How Do Optimization Algorithms Work?

159

(17)

Optimization Software

176

(4)

Practical Considerations when Using Optimization Software

180

(7)

Summary

187

(2)

PART TWO Managing Uncertainty in Practice

189

(132)

CHAPTER 7 Equity Price Models

191

(24)

Definitions

191

(2)

Theoretical and Econometric Models

193

(1)

Random Walk Models

194

(13)

General Equilibrium Theories

207

(1)

Capital Asset Pricing Model (CAPM)

208

(4)

Arbitrage Pricing Theory (APT)

212

(1)

Summary

213

(2)

CHAPTER 8 Forecasting Expected Return and Risk

215

(52)

Dividend Discount and Residual Income Valuation Models

217

(5)

The Sample Mean and Covariance Estimator

222

(9)

Random Matrices

231

(3)

Arbitrage Pricing Theory and Factor Models

234

(7)

Factor Models in Practice

241

(4)

Factor Models in Practice: An Example

245

(14)

Other Approaches to Volatility Estimation

259

(5)

Application to Investment Strategies and Proprietary Trading

264

(1)

Summary

265

(2)

CHAPTER 9 Robust Frameworks for Estimation and Portfolio Allocation

267

(54)

Robust Frameworks for Estimation and Portfolio Allocation

267

(2)

Practical Problems Encountered in Mean-Variance Optimization

269

(6)

Shrinkage Estimation

275

(6)

Bayesian Approaches

281

(23)

Incorporating Estimation Error and Uncertainty in the Portfolio Allocation Process

304

(14)

Summary

318

(3)

PART THREE Dynamic Models for Equity Prices

321

(116)

CHAPTER 10 Feedback and Predictors in Stock Markets

323

(24)

Random Walk Models and Their Shortcomings

323

(10)

Time Diversification

333

(6)

A Multiagent Economy: Effects of Agent Heterogeneity and Interactions

339

(4)

Market Predictors

343

(2)

Time Aggregation

345

(1)

Summary

345

(2)

CHAPTER 11 Individual Price Processes: Univariate Models

347

(20)

Time Series Concepts

348

(2)

Digression on White Noise and Martingale Difference Sequences

350

(3)

The Lag Operator L

353

(1)

Univariate Autoregressive Moving Average (ARMA) Models

353

(1)

Stationarity Conditions

354

(3)

Auto Correlations at Different Lags

357

(1)

Solutions of an AR(p) Process

358

(4)

MA(q) Moving Average Models

362

(1)

ARMA(p,q) Models

363

(1)

Integrated Processes

364

(1)

Summary

365

(2)

CHAPTER 12 Multivariate Models

367

(40)

Dynamic Models: A Historical Perspective

368

(2)

Vector Autoregressive Models

370

(15)

Vector Autoregressive Moving Average Models (VARMA)

385

(1)

Distributional Properties

386

(1)

Cointegration

386

(6)

Stochastic and Deterministic Cointegration

392

(1)

Common Trends

393

(2)

Error Correction Models

395

(1)

Forecasting with VAR Models

396

(1)

State-Space Models

397

(2)

Autoregressive Distributed Lag Models

399

(3)

Dynamic Factor Models

402

(1)

The ARCH/GARCH Family of Models

402

(2)

Nonlinear Markov-Switching Models

404

(1)

Summary

405

(2)

CHAPTER 13 Model Selection and its Pitfalls

407

(30)

Model Selection and Estimation

407

(3)

The (Machine) Learning Approach to Model Selection

410

(5)

Sample Size and Model Complexity

415

(4)

Dangerous Patterns of Behavior

419

(5)

Data Snooping

424

(2)

Survivorship Biases and Other Sample Defects

426

(2)

Moving Training Windows

428

(2)

Model Risk

430

(1)

Model Selection in a Nutshell

431

(2)

Summary

433

(4)

PART FOUR Model Estimation and Model Risk Mitigation

437

(140)

CHAPTER 14 Estimation of Regression Models

439

(38)

Probability Theory and Statistics

439

(3)

Populations of Prices and Returns

442

(2)

Estimation at Work

444

(1)

Estimators

445

(1)

Sampling Distributions

446

(4)

Critical Values and Confidence Intervals

450

(1)

Maximum Likelihood, OLS, and Regressions

450

(3)

The Fisher Information Matrix and the Cramer-Rao Bound

453

(1)

Regressions

454

(2)

Linear Regressions

456

(8)

Sampling Distributions of Regressions

464

(4)

Relaxing the Normality and Uncorrelated Noise Assumptions

468

(1)

Pitfalls of Regressions

469

(2)

The Method of Moments and its Generalizations

471

(4)

Summary

475

(2)

CHAPTER 15 Estimation of Linear Dynamic Models

477

(52)

An Approach to Estimation

477

(1)

Unit Root Testing

478

(1)

Estimation of Linear Regression Models

479

(3)

Estimation of Stable Vector Autoregressive (VAR) Models

482

(17)

Estimating the Number of Lags

499

(2)

Autocorrelation and Distributional Properties of Residuals

501

(1)

Stationary Autoregressive Distributed Lag Models

502

(1)

Applying Stable VAR Processes to Financial Econometrics

503

(3)

Stationary Dynamic Factor Models

506

(3)

Estimation of Nonstationary VAR Models

509

(11)

Estimation with Canonical Correlations

520

(1)

Estimation with Principal Component Analysis

521

(2)

Estimation with the Eigenvalues of the Companion Matrix

523

(1)

Estimation with Subspace Methods and Dynamic Factor Analysis

524

(1)

Application of Cointegration Methods to the Analysis of Predictors

524

(1)

Summary

525

(4)

CHAPTER 16 Estimation of Hidden Variable Models

529

(26)

Estimation of State-Space Models

530

(13)

Estimation of Factor Analytic Models

543

(3)

Estimation Methods for Markov-Switching Models

546

(2)

Applications

548

(4)

Summary

552

(3)

CHAPTER 17 Model Risk and its Mitigation

555

(22)

Sources of Model Risk

555

(3)

The Information Theory Approach to Model Risk

558

(5)

Bayesian Modeling

563

(10)

Model Averaging and the Shrinkage Approach to Model Risk

573

(1)

Random Coefficients Models

574

(1)

Summary

575

(2)

APPENDICES

577

(52)

APPENDIX A Difference Equations

579

(24)

Homogeneous Difference Equations

579

(9)

Nonhomogeneous Difference Equations

588

(6)

Systems of Linear Difference Equations

594

(1)

Systems of Homogeneous Linear Difference Equations

595

(8)

APPENDIX B Correlations, Regressions, and Copulas

603

(16)

Probability Density Function, Marginal Density, and Conditional Density

603

(1)

Expectations and Conditional Expectations

604

(2)

Variances, Covariances, and Correlations

606

(2)

Normal Distributions

608

(2)

Regression

610

(2)

Multivariate Extension

612

(1)

Multiple and Multivariate Regressions

613

(2)

Canonical Correlations

615

(1)

Copula Functions

616

(3)

APPENDIX C Data Description

619

(10)

INDEX

629

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Financial Modeling of the Equity Market From CAPM to Cointegration

Summary

Author Biography

Table of Contents

Supplemental Materials