1. Motivation Imagine you're a financial economist who thinks that some risk factor,${\color{white}i}f_t$, explains the cross-section of expected returns. And, you decide to test your hunch. First, you regress the realized returns of $N$ different … [Continue reading]
Motivation This post is motivated by two stylized facts about bubbles and crashes. The first is that these events are often attributed to the madness of crowds. In popular accounts, they occur when a large number of inexperienced traders floods into … [Continue reading]
Motivation Trading has gotten a lot faster over the last two decades. The term "short-run trader" used to refer to people who traded multiple times a day. Now, it refers to algorithms that trade multiple times a second. Some people are worried … [Continue reading]
1. Motivation Imagine we're traders in a market where the cross-section of returns is related to $V \geq 1$ variables: \begin{align*} r_s = \alpha^\star + {\textstyle \sum_v} \, \beta_v^{\star} \cdot x_{s,v} + … [Continue reading]
1. Motivation Traders are constantly looking for variables that predict returns. If $x$ is the only candidate variable traders are considering, then it's easy to use the Bayesian information criterion to check whether $x$ predicts returns. … [Continue reading]