# Category: Finance and Trading

## Energy idiosyncratic volatility

Recently, volatility has been on the up. Generally, we associate rising volatility with a bear regime, but we also know there is a percolating oil shock. Is the volatility we see in the stock market broad-based, or is it the effect brought about by sharp the drop in oil prices (so related to the energy sector)? I propose here a practical way to take a closer look at it.

## Fed Fund Rate futures curve and what they tell us

“The Fed is certainly moving forward with plans to normalize interest rates.” We keep on hearing that, we believed it in the past and we believe it now. We believe that the Fed believes and that, in fact, this means something.

Should we become more suspicious and less trusting given history? Let’s take a look.

## Linking backtesting with multiple testing

The other day, Harvey Campbell from Duke University gave a talk where I work. The talk- bearing the exciting name “Backtesting” was based on a paper by the same name.

The authors tackle the important problem of data-snooping; we need to account for the fact that we conducted many trials until we found a strategy (or a variable) that ‘works’. Accessible explanations can be found here and here. In this day and age, the ‘story’ behind what you are doing is more important than ever, given the things you can do using your desktop/laptop.

## Mom, are we bear yet? (2)

5 weeks ago we took a look at the rising volatility in the (US) equity markets via a time-series threshold model for the VIX. The estimate suggested we are crossing (or crossed) to the more volatile regime. Here, taking somewhat different Hidden Markov Model (HMM) approach we gather more corroboration (few online references at the bottom if you are not familiar with HMM models. The word hidden since the state is ‘invisible’).

## On the nonfarm payroll number

The total nonfarm payroll accounts for approximately 80% of the workers who produce the GDP of the United States. Despite the widely acknowledged fact that the Nonfarm payroll is highly volatile and is heavily revised, it is still driving both bonds and equity market moves before- and after it is published. The recent number came at a weak 142K compared with around 200K average over the past 12M. What we wish we would know now, but will only know later, is whether this number is a start of a weaker expansion in the workforce, or not.

Despite the fact that it is definitely on the weak side (as you can see in the top panel of the figure), it is nothing unusual (as you can see in the bottom panel of the figure).

The bottom panel charts the interval you have before the number is publish (forecast intervals) from a simple AR(1) model without imposing normality. The blue and the red lines are 1 and 2 standard deviations respectively. The recent number barely scratches the bottom blue, so nothing to suggest a significant shift from a healthy 200K. On the other hand, there is some persistence:

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ar.ols(na.omit(nfp)) Call: ar.ols(x = na.omit(nfp)) Coefficients: 1 2 3 4 5 6 0.2633 0.2672 0.1402 0.0841 0.1015 -0.0853 Intercept: 0.318 (5.906) Order selected 6 sigma^2 estimated as 31430 |

So, on average we can expect to trend lower.

Code for figure:

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library(quantmod) library(Eplot) tempenv <- new.env() getSymbols("PAYEMS",src="FRED",env=tempenv) # Bring it to global env head(tempenv$PAYEMS) time <- index(tempenv$PAYEMS) nfp <- as.numeric(diff(tempenv$PAYEMS)) par(mfrow = c(2,1)) k = 24 args(plott) plott(tail(nfp,k),tail(time,k),return.to.default = F,main="NFP-changes") args(FCIplot) nfpsd <- FCIplot(nfp,k=k,rrr1="Rol",rrr2="Rol",main="NFP-changes; forecast intervals superimposed") |

## Mom, are we bear yet?

One way to help us decide is to estimate a regime switching model for the VIX, see if the volatility crossed over to the bear regime.

## Non-linear beta

If you google-finance AMZN you can see the beta is 0.93. I already wrote in the past about this illusive concept. Beta is suppose to reflect the risk of an instrument with respect for example to the market. However, you can estimate this measure in all kind of ways.

## Detecting bubbles in real time

Recently, we hear a lot about a housing bubble forming in UK. Would be great if we would have a formal test for identifying a bubble evolving in real time, I am not familiar with any such test. However, we can still do *something* in order to help us gauge if what we are seeing is indeed a bubbly process, which is bound to end badly.

## Bootstrap criticism

The title reads *Bootstrap criticism*, but in fact it should be Non-parametric bootstrap criticism. I am all in favour of Bootstrapping, but I point here to a major drawback.

## Stocks with upside potential

THIS IS NOT INVESTMENT ADVICE. ACTING BASED ON THIS POST MAY, AND IN ALL PROBABILITY WILL, CAUSE MONETARY LOSS.

Quantile regression is now established as an important econometric tool. Unlike mean regression (OLS), the target is not the mean given x but some quantile given x. You can use it to find stocks that present good upside potential. You may think it has to do with the beta of a stock, but the beta is OLS-related, and is symmetric. High-beta stock rewards with an upside swing if the market spikes but symmetrically, you can suffer a large draw-down when the market drops. This is not an upside potential.

## Quantile Autoregression in R

In the past, I wrote about robust regression. This is an important tool which handles outliers in the data. Roger Koenker is a substantial contributor in this area. His website is full of useful information and code so visit when you have time for it. The paper which drew my attention is “Quantile Autoregression” found under his research tab, it is a significant extension to the time series domain. Here you will find short demonstration for stuff you can do with quantile autoregression in R.

## Live Correlation plot, shiny improvement.

Open CPU is a great project. Few months back, I wrote a function for plotting a moving window of the market average correlation. Jeroen C.L. Ooms was nice enough to upload it to their server. Something is now changed. Quotes now return as a character class, as oppose to numeric. This messes up the function and the plot does not renders. I don’t wish to disturb Jeroen C.L. Ooms again with the correction for the code (despite his kind replies in the past). This problem creates the opportunity to look at the glistening “Shiny” package. I used it to (quickly..) build an app for the plot. You can now view a live correlation plot with the moving window of your choice. Live, as the app requests **current **market data. The width of the window for correlation calculation is given as an input parameter.

## A Simple Model for Realized Volatility

The post has two goals:

**(1)** Explain how to forecast volatility using a simple Heterogeneous Auto-Regressive (HAR) model. (Corsi, 2002)

**(2)** Check if higher moments like Skewness and Kurtosis add forecast value to this model.

## On Volatility Proxy

Volatility is unobserved. Hence we need to use observed quantity as a proxy. Every once in a while I still see people using squared daily return as a proxy. However, there is ample evidence that it is a bad one. Bad in a sense that it is noisy, which means that although on average it is a good estimate, on any individual day the estimate can be very far from the actual unobserved volatility. Here is a figure of the alleged standard deviation in the form of (square root of the) squared daily return for the recent year:

You can see that in many days, this noisy estimate suggests that the volatility was around 2% and more. To me, it does not make too much sense. The series is the S&P 500, so a move of 3% is a BIG one. You can also see how “jumpy” the series is. The figure illustrates why we should avoid using this estimate.