Archive | October, 2011

POSSIBLE CAUSE OF A NEW FINANCIAL SHOCK WAVE

23 Oct

I think that a terrorist attack, similar to 9/11, will cause another financial     shock wave. The 9/11 attack had big economic effects that instigated a         global drop in the stock markets. Furthermore, there were billions of             dollars caused in insurance losses. For these reasons, a similar occurrence will certainly have equivalent consequences at least. Nevertheless, I argue that such an event will cause further losses and more extravagant effects. This is due to the fact that after 9/11, governments became very precautious about possible terrorism, and many resources were put towards security. As a result, people think that they are safer and that a new series of attacks would be very unlikely (an adverse selection event). In addition to this, the dead of the former leader of Al-Qaeda has surely lead people to feel safer, so another attack will definitely be very surprising.  In the end, there would be more panic, which will further cause fear within the markets and thus, spreading it throughout the world and many other economic sectors. This could cause a new financial shock wave.

Question of the week: Is it possible to find the optimization values using eigenvalues from matrices? If so, how would it be possible?

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CORRELATION OF RISKY ASSETS

14 Oct

In first place, I would like to emphasize on the importance of calculating the correlation between a sample of stocks or other risky assets. Knowing the correlation is important in creating a portfolio because it helps to diversify risk. In other words, you do not want to own two positively correlated items because if the price of either falls, then the price of the other correlated asset will fall too.

Taking the previous into consideration, an example of two correlated stocks is Google and Microsoft. This could be explained by the fact that both corporations are big competitors of the “technology era.”

Actually, after doing some research, I found out that the correlation between these two corporations is 0.79.

Source: http://www.macroaxis.com/invest/menu/pitchletHome/marketCorrelation

Question of the week: What is considered to be a good range of correlation between risky assets in a portfolio? For example, would you say that a correlation of 0.5 (-0.5) is high? Is it possible to build a portfolio with correlation equal to 0?

DIFFERENT INVESTORS

2 Oct

I believe that old investor s may have a comparative advantage over young investors due to their experience within investing. As we know, it is impossible to predict the behavior of the market. Nevertheless, old investors could have a better understanding of the market following fluctuations, catastrophes, and any other events that may affect the market, and thus, will probably use different statistical models or variations. For example, older investors could be more aware of inflation than modest income ones because the latters haven´t really experienced it yet. In such situation, one could assume that younger investors will invest riskier.

Nonetheless, I would like to argue that now day’s young investors are probably very cautious about their investments. With the recent disruption in the financial markets, many investors are shrinking investment accounts. In other words, younger investors are more risk averse than older investors.

Furthermore, I also believe that very wealthy investors will bear more risk than modest income investors because their budget constraint and their indifference curves are higher than those of modest income investors.  Hence, wealthy investors could afford to invest risky, if they are willing to, because they have the money to afford any losses. In comparison, modest income investors will be more concerned about retaining and increasing profits by investing safe. Hence, they will use better statistical tools in order to spread out the risks.

Question of the week: I know there are different methods to calculate risk, one of them being volatility. What do you think is the best method to calculate the risks of a “worst-case scenario”?