Estimation error on apparent arbitrage, Applied Statistics

Assignment Help:

This question explores the effect of estimation error on apparent arbitrage opportunities in a controlled simulation setting. We simulate returns for N = 10 assets over T = 30 years. We will use the first 20 years for estimation and the selection of the hedge portfolio ("in-sample"), and the remaining 10 years as "out-of-sample" performance evaluation period. Start out with a market return RM that is normally distributed with mean μM = 0:05 and standard deviation σM = 0:15, and assume a risk-free rate Rf = 0. All assets follow the factor model Rn,t = αn + βnRM,t + εn,t, where we assume n = 1 for all n.

We will consider three sets of parameters for the return generating process.

1428_Estimation error on apparent arbitrage.png

For each parameterization, perform 100 simulations (data table) for returns on market-neutral zero-investment portfolios and report the average holding period mean return and how often you investment loses money over the performance evaluation period assuming that

i) You know the parameters of the return generating process and invest equal amounts in every stock with positive alpha and short equal amounts of every stock with negative alpha

ii) You estimate the parameters and invest $1 in the stock with the highest alpha (if there is one), and short $1 of the stock with the most negative alpha (if there is one)

iii) You estimate the parameters and invest equal amounts in every stock with positive alphas (if there are) and short equal amounts of every stock with negative alphas (if there are)

iv) You estimate the parameters and come up with a more sophisticated investment strategy. Compare and explain your findings.

Notes

  • Start out with fewer simulations in your data table until you are con dent everything works
  • Your investment should hedge out all market risk (using your best estimates)
  • Take great care programming the portfolio weights in (ii)-(iv). If everything is done right, changing parameters and running the simulations should not take much time.

Related Discussions:- Estimation error on apparent arbitrage

Characteristics of index number, Characteristics of Index Number  On th...

Characteristics of Index Number  On the analysis of various definitions of index number the following may be its characteristics: 1.      Expressed in Number : Index number

Effect in frequency domain, A) The three images shown below were blurred us...

A) The three images shown below were blurred using square masks of sizes n=23, 25, and 45, respectively. The vertical bars on the le_ lower part of (a) and (c) are blurred, but a c

Calculate the normal loss and abnormal loss, Chemical processors manufactur...

Chemical processors manufacture wondercool using two processes- mixing and distillation. The following details relate to the distillation process for a period. No opening work i

Determine the maximum weight rounded down, Assume that the pulley at A is a...

Assume that the pulley at A is a small frictionless pulley. The cord AB is only allowed to support a maximum tension in Newtons as given in P4, and the cord supporting the block ca

Testing of hypothesis, Testing of Hypothesis One objective of sampling...

Testing of Hypothesis One objective of sampling theory is Hypothesis Testing. Hypothesis testing begins by making an assumption about the population parameter. Then we gather

Theoretical yield and actual yield, Write down the symbols and unit for the...

Write down the symbols and unit for the following: mass, molar mass, molar and molarity Write down the relationship between mass and molar mass and show that the units match.

Determine percent of population in city - bayes theoram, (1) Assume we cat...

(1) Assume we categorize voters in a city as havingless educationand those havingmoreeducation. Those with less education have less than a college degree; those with more education

Local truncation error, (a) If one solves the ordinary differential equati...

(a) If one solves the ordinary differential equation using Euler's method find an expression for the local truncation error. (b) Using the result of (a) above what will

Statistics assignment, To compare three brands of computer keyboards, four ...

To compare three brands of computer keyboards, four data entry specialists were randomly selected. Each specialist used all three keyboards to enter the same kind of text material

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd