Comments on: Finding the Market Bottom http://messymatters.com/2009/04/07/finding-the-market-bottom/ Bring Your Own Data Sat, 17 Jul 2010 16:50:31 +0000 http://wordpress.org/?v=2.9.1 hourly 1 By: randomactsofmath http://messymatters.com/2009/04/07/finding-the-market-bottom/comment-page-1/#comment-43 randomactsofmath Sat, 18 Apr 2009 21:47:27 +0000 http://messymatters.com/?p=76#comment-43 Sharad and dreeves, Thanks! It was indeed the use of the term "bear market", that was confusing. For a risk-neutral investor, the volatility means nothing, but once one factors in the asymmetric treatment of gains and losses, it becomes a lot more clear. I do not know enough about Cumulative Prospect Theory, but it could be interesting to work out what this number says about the expectations of those trading the markets, according to CPT assumptions. I look forward to more posts. Sharad and dreeves,

Thanks! It was indeed the use of the term “bear market”, that was confusing. For a risk-neutral investor, the volatility means nothing, but once one factors in the asymmetric treatment of gains and losses, it becomes a lot more clear. I do not know enough about Cumulative Prospect Theory, but it could be interesting to work out what this number says about the expectations of those trading the markets, according to CPT assumptions.

I look forward to more posts.

]]> By: Sharad Goel http://messymatters.com/2009/04/07/finding-the-market-bottom/comment-page-1/#comment-42 Sharad Goel Tue, 14 Apr 2009 13:31:36 +0000 http://messymatters.com/?p=76#comment-42 dreeves, thanks for clarifying my (non-standard) use of "bear market." For the record, the position I'm espousing is the traditional one, at least in academic circles. From <a href="http://en.wikipedia.org/wiki/Market_trends" rel="nofollow">Wikipedia</a>: The idea that markets move in cycles with regularity and persistence "is broadly <b>inconsistent</b> with the standard academic view of financial markets." dreeves, thanks for clarifying my (non-standard) use of “bear market.”

For the record, the position I’m espousing is the traditional one, at least in academic circles. From Wikipedia: The idea that markets move in cycles with regularity and persistence “is broadly inconsistent with the standard academic view of financial markets.”

]]> By: dreeves http://messymatters.com/2009/04/07/finding-the-market-bottom/comment-page-1/#comment-41 dreeves Mon, 13 Apr 2009 18:23:01 +0000 http://messymatters.com/?p=76#comment-41 R.A. O'Math, I don't think Sharad is claiming such correlation. He's just saying that when people less disingenuous than Jim Cramer are bearish or bullish they can't literally be predicting the direction of the market. So he's giving them the benefit of the doubt that they are predicting volatility instead. If you're risk-averse then a volatile market is more bearish than bullish. R.A. O’Math,
I don’t think Sharad is claiming such correlation. He’s just saying that when people less disingenuous than Jim Cramer are bearish or bullish they can’t literally be predicting the direction of the market. So he’s giving them the benefit of the doubt that they are predicting volatility instead. If you’re risk-averse then a volatile market is more bearish than bullish.

]]> By: randomactsofmath http://messymatters.com/2009/04/07/finding-the-market-bottom/comment-page-1/#comment-40 randomactsofmath Sun, 12 Apr 2009 19:15:59 +0000 http://messymatters.com/?p=76#comment-40 I think your ideas are interesting and I will certainly be following your blog. However, I am not convinced that high volatility implies a bear market. It certainly implies the "possibility" of a bear outcome. Are bull markets correlated with lower volatility? It would be great to see an additional chart depicting that. I think your ideas are interesting and I will certainly be following your blog. However, I am not convinced that high volatility implies a bear market. It certainly implies the “possibility” of a bear outcome. Are bull markets correlated with lower volatility? It would be great to see an additional chart depicting that.

]]> By: Sharad Goel http://messymatters.com/2009/04/07/finding-the-market-bottom/comment-page-1/#comment-37 Sharad Goel Wed, 08 Apr 2009 12:57:40 +0000 http://messymatters.com/?p=76#comment-37 John asks (via email) how monthly volatility is computed from yearly volatility. Here's the answer. It's assumed (e.g., in <a href="http://en.wikipedia.org/wiki/Black-Scholes" rel="nofollow">Black-Scholes</a>) that the log stock price process follows a Brownian motion, and that volatility is the standard deviation of this random walk. If X<sub>i</sub> is the change in the walk in month i, the change in a year is X = X<sub>1</sub> + X<sub>2</sub> + ... + X<sub>12</sub>. By independence, <p align="center">σ<sub>yearly</sub> = √12 σ<sub>monthly</sub>.</p> This model assumes constant volatility. Implied volatility, however, has been empirically observed to depend both on an option's strike price and on its time to maturity, leading to the <a href="http://en.wikipedia.org/wiki/Volatility_smile" rel="nofollow">volatility smile</a>. John asks (via email) how monthly volatility is computed from yearly volatility. Here’s the answer. It’s assumed (e.g., in Black-Scholes) that the log stock price process follows a Brownian motion, and that volatility is the standard deviation of this random walk. If Xi is the change in the walk in month i, the change in a year is X = X1 + X2 + … + X12. By independence,

σyearly = √12 σmonthly.

This model assumes constant volatility. Implied volatility, however, has been empirically observed to depend both on an option’s strike price and on its time to maturity, leading to the volatility smile.

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