Equity Management: The Art and Science of Modern Quantitative Investing, Second Edition

Cover
Title Page
Copyright Page
Dedication
Contents
Foreword to the First Edition
Foreword to the Second Edition
Preface to the Second Edition
Acknowledgments
Introduction Our Approach to Quantitative Investing
Part One Profiting in a Multidimensional, Dynamic World
	Chapter 1 Ten Investment Insights That Matter
		The Stock Market Is a Complex System
		Market Complexity Can be Exploited with a Rich, Multidimensional Model
		Return-Predictor Relationships Should Be Disentangled
		An Investment Firm Should Abide by the Law of One Alpha
		The Investment Process Should Be Dynamic and Transparent
		A Customized, Integrated Investment Process Preserves Insights
		Integrated Long-Short Optimization Can Provide Enhanced Returns and Risk Control for Market-Neutral  and 130-30 Portfolios
		Alpha from Security Selection Can Be Transported to Any Asset Class
		Portfolio Optimization Should Take into Account an Investor’s Aversion to Leverage
		Beware of Risk Shifting, Free Lunches, and Irrational Markets
		Conclusion
	Chapter 2 The Complexity of the Stock Market
		The Evolution of Investment Practice
		Web of Return Regularities
		Disentangling and Purifying Returns
		Advantages of Disentangling
		Evidence of Inefficiency
		Value Modeling in an Inefficient Market
		Risk Modeling versus Return Modeling
		Pure Return Effects
		Anomalous Pockets of Inefficiency
		Empirical Return Regularities
		Modeling Empirical Return Regularities
		Bayesian Random Walk Forecasting
		Conclusion
	Chapter 3 Disentangling Equity Return Regularities: New Insights and Investment Opportunities
		Previous Research
		Return Regularities We Consider
		Methodology
		The Results on Return Regularities
		P/E and Size Effects
		Yield, Neglect, Price, and Risk
		Trends and Reversals
		Some Implications
		January versus Rest-of-Year Returns
		Autocorrelation of Return Regularities
		Return Regularities and Their Macroeconomic Linkages
		Conclusion
	Chapter 4 On the Value of “Value”
		Value and Equity Attributes
		Market Psychology, Value, and Equity Attributes
		The Importance of Equity Attributes
		Examining the DDM
		Methodology
		Stability of Equity Attributes
		Expected Returns
		Naïve Expected Returns
		Pure Expected Returns
		Actual Returns
		Power of the DDM
		Power of Equity Attributes
		Forecasting DDM Returns
		Conclusion
	Chapter 5 Calendar Anomalies: Abnormal Returns at Calendar Turning Points
		The January Effect
		Rationales
		The Turn-of-the-Month Effect
		The Day-of-the-Week Effect
		Rationales
		The Holiday Effect
		The Time-of-Day Effect
		Conclusion
	Chapter 6 Forecasting the Size Effect
		The Size Effect
		Size and Transaction Costs
		Size and Risk Measurement
		Size and Risk Premiums
		Size and Other Cross-Sectional Effects
		Size and Calendar Effects
		Modeling the Size Effect
		Simple Extrapolation Techniques
		Time-Series Techniques
		Transfer Functions
		Vector Time-Series Models
		Structural Macroeconomic Models
		Bayesian Vector Time-Series Models
		Appendix
	Chapter 7 Earnings Estimates, Predictor Specification, and Measurement Error
		Predictor Specification and Measurement Error
		Alternative Specifications of E/P and Earnings Trend for Screening
		Alternative Specifications of E/P and Trend for Modeling Returns
		Predictor Specification with Missing Values
		Predictor Specification and Analyst Coverage
		The Return-Predictor Relationship and Analyst Coverage
		Summary
Part Two Managing Portfolios in a Multidimensional, Dynamic World
	Chapter 8 Engineering Portfolios: A Unified Approach
		Is the Market Segmented or Unified?
		A Unified Model
		A Common Evaluation Framework
		Portfolio Construction and Evaluation
		Engineering “Benchmark” Strategies
		Added Flexibility
		Economies
	Chapter 9 the Law of one Alpha
	Chapter 10 Residual Risk: How Much is too Much?
		Beyond the Curtain
		Some Implications
	Chapter 11 High-Definition Style Rotation
		High-Definition Style
		Pure Style Returns
		Implications
		High-Definition Management
		Benefits of High-Definition Style
	Chapter 12 Smart Beta versus Smart Alpha
		Supported by Theory?
		Active or Passive?
		Forward-Looking and Dynamic?
		Concentrated Risk Exposures?
		Unintended Risk Exposures?
		Factor Integration and Risk Control?
		Turnover Levels?
		Liquidity and Overcrowding?
		Transparent or Proprietary?
		Conclusion
	Chapter 13 Smart Beta: Too Good to Be True?
		Smart Beta Portfolios Are Passive
		Smart Beta Targets the Most Significant Return-Generating Factors
		Smart Beta Portfolios Are Well Diversified
		Smart Beta Factors Perform Consistently
		Smart Beta Portfolios Benefit from Mean-Reversion in Prices
		Smart Beta Portfolios Can Be Efficiently Combined
		Smart Beta Benefits from Transparency
		Smart Beta Has Nearly Unlimited Capacity
		Smart Beta Streamlines the Investment Decision Process for Investors
		Smart Beta Costs Less Than Active Investing
		Conclusion
	Chapter 14 Is Smart Beta State of the Art?
	Chapter 15 Investing in a Multidimensional Market
		The Market’s Multidimensionality
		Advantages of a Multidimensional Approach
		Conclusion
Part Three Expanding Opportunities with Market-Neutral Long-Short Portfolios
	Chapter 16 Long-Short Equity Investing
		Long-Short Equity Strategies
		Societal Advantages of Short-Selling
		Equilibrium Models, Short-Selling, and Security Prices
		Practical Benefits of Long-Short Investing
		Portfolio Payoff Patterns
		Long-Short Mechanics and Returns
		Theoretical Tracking Error
		Advantages of the Market-Neutral Strategy Over Long Manager Plus Short Manager
		Advantages of the Equitized Strategy Over Traditional Long Equity Management
		Implementation of Long-Short Strategies: Quantitative versus Judgmental
		Implementation of Long-Short Strategies: Portfolio Construction Alternatives
		Practical Issues and Concerns
		Shorting Issues
		Trading Issues
		Custody Issues
		Legal Issues
		Morality Issues
		What Asset Class is Long-Short?
		Conclusion
	Chapter 17 20 Myths About Long-Short
	Chapter 18 The Long and Short on Long-Short
		Building a Market-Neutral Portfolio
		A Question of Efficiency
		Benefits of Long-Short
		Equitizing Long-Short
		Trading Long-Short
		Evaluating Long-Short
	Chapter 19 Long-Short Portfolio Management: An Integrated Approach
		Long-Short: Benefits and Costs
		The Real Benefits of Long-Short
		Costs: Perception versus Reality
		The Optimal Portfolio
		Neutral Portfolios
		Optimal Equitization
		Conclusion
	Chapter 20 Alpha Transport with Derivatives
		Asset Allocation or Security Selection
		Asset Allocation and Security Selection
		Transporter Malfunctions
		Matter-Antimatter Warp Drive
		To Boldly Go
Part Four Expanding Opportunities with Enhanced Active 130-30 Portfolios
	Chapter 21 Enhanced Active Equity Strategies: Relaxing the Long-Only Constraint in the Pursuit of Active Return
		Approaches to Equity Management
		Enhanced Active Equity Portfolios
		Performance: An Illustration
		The Enhanced Prime Brokerage Structure
		Operational Considerations
		Comparison to Other Long-Short Strategies
		Conclusion
		Appendix: Weighted-Average Capitalization Weights
	Chapter 22 20 Myths About Enhanced Active 120-20 Strategies
	Chapter 23 Enhanced Active Equity Portfolios are Trim Equitized Long-Short Portfolios
		Market-Neutral, Equitized, and Enhanced Active Portfolios
		Trimming an Equitized Portfolio
		Enhanced Active Versus Equitized Portfolios
		Benchmark Index Choices
		Conclusion
	Chapter 24 On the Optimality of Long-Short Strategies
		Portfolio Construction and Problem Formulation
		Optimal Long-Short Portfolios
		Optimality of Dollar Neutrality
		Optimality of Beta Neutrality
		Optimal Long-Short Portfolio with Minimum Residual Risk
		Optimal Long-Short Portfolio with Specified Residual Risk
		Optimal Equitized Long-Short Portfolio
		Optimality of Dollar Neutrality with Equitization
		Optimality of Beta Neutrality with Equitization
		Optimal Equitized Long-Short Portfolio with Specified Residual Risk
		Optimal Equitized Long-Short Portfolio with Constrained Beta
		Conclusion
Part Five Optimizing Portfolios with Short Positions
	Chapter 25 Trimability and Fast Optimization of Long-Short Portfolios
		General Mean-Variance Problem
		Long-Short Constraints in Practice
		Diagonalized Models of Covariance
		Factor Models
		Scenario Models
		Historical Covariance Models
		Modeling Long-Short Portfolios
		Applying Fast Techniques to the Long-Short Model
		Trimability
		Consequences of Trimability
		Example
		Summary
	Chapter 26 Portfolio Optimization with Factors, Scenarios, and Realistic Short Positions
		The General Mean-Variance Problem
		Solution to the General Problem
		Diagonalizable Models of Covariance
		Factor Models
		Scenario Models
		Historical Covariance Matrices
		Short Sales in Practice
		Modeling Short Sales
		Solution to Long-Short Model
		Example
		Summary
Part Six Optimizing Portfolios for Leverage-Averse Investors
	Chapter 27 Leverage Aversion and Portfolio Optimality
		Optimal Enhancement with Leverage Aversion
		An Example with Leverage Aversion
		Conclusion
	Chapter 28 Leverage Aversion, Efficient Frontiers, and the Efficient Region
		Specifying the Leverage-Aversion Term
		Specification of the Leverage-Aversion Term Using Portfolio Total Volatility
		Optimal Portfolios with Leverage Aversion Based on Portfolio Total Volatility
		Efficient Frontiers with and Without Leverage Aversion
		Efficient Frontiers for Various Leverage-Tolerance Cases
		The Efficient Region
		Conclusion
		Appendix: Comparison of the Enhancement Surfaces Using two Different Specifications
	Chapter 29 Introducing Leverage Aversion into Portfolio Theory and Practice
	Chapter 30 A Comparison of the Mean-Variance-Leverage Optimization Model and the Markowitz General Mean-Variance Portfolio Selection Model
		Leverage Risk—A Third Dimension
		Quartic Versus Quadratic Optimization
		Practical Insights from the MVL Optimization Model
		Conclusion
	Chapter 31 Traditional Optimization Is Not Optimal for Leverage-Averse Investors
		Mean-Variance Optimization with a Leverage Constraint
		The Leverage-Averse Investor’s Utility of Optimal Mean-Variance Portfolios
		Mean-Variance-Leverage Optimization Versus Leverage-Constrained Mean-Variance Optimization
		Conclusion
	Chapter 32 The Unique Risks of Portfolio Leverage: Why Modern Portfolio Theory Fails and How to Fix it
		The Limitations of Mean-Variance Optimization
		Mean-Variance Optimization with Leverage Constraints
		Mean-Variance-Leverage Optimization
		Optimal Mean-Variance-Leverage Portfolios and Efficient Frontiers
		The Mean-Variance-Leverage Efficient Region
		The Mean-Variance-Leverage Efficient Surface
		Optimal Mean-Variance-Leverage Portfolios versus Optimal Mean-Variance Portfolios
		Volatility and Leverage in Real-Life Situations
		Conclusion
Part Seven Shifting Risk Can Lead to Financial Crises
	Chapter 33 Option Pricing Theory and Its Unintended Consequences
	Chapter 34 When Seemingly Infallible Arbitrage Strategies Fail
	Chapter 35 Momentum Trading: The New Alchemy
	Chapter 36 Risk Avoidance and Market Fragility
		Insuring Specific versus Systematic Risk
		Insurance and Systemic Risk
		Risk Sharing versus Risk Shifting
	Chapter 37 Tumbling Tower of Babel: Subprime Securitization and the Credit Crisis
		Risk-Shifting Building Blocks
		RMBSs
		ABCP, SIVs, and CDOs
		CDSs
		What Goes Up ...
		The Rise of Subprime
		Low Risk for Sellers and Buyers
		High Risk for the System
		... Must Come Down
		Positive Feedback’s Negative Consequences
		Fault Lines
		Conclusion: Building from the Ruins
Part Eight Simulating Security Markets
	Chapter 38  Financial Market Simulation
		Types of Dynamic Models
		JLM Market Simulator
		Status
		Events
		Objectives and Extensions
		Alternative Investor and Trader Behaviors
		Model Size
		Advantages of Asynchronous Finance Models
		Caveat
		Conclusion
	Chapter 39 Simulating Security Markets in Dynamic and Equilibrium Modes
		Simulation Overview
		Dynamic Analysis
		Different Initial Random Seeds
		Different Ratios of Momentum to Value Investors
		Trading and Anchoring Rules
		Capital Market Equilibrium
		Expected Return Estimation Method
		Case Study
		Conclusion
List of Acronyms
Glossary
Name Index
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Subject Index
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