TYPES OF MODELS UNDERLYING INVESTMENT STRATEGIES

Question 1

Describe the difference between normative and positive reasoning in investment strategies.

Answer 1

Normative reasoning attempts to describe how people and prices ought to behave, while positive reasoning attempts to describe how people and prices actually behave.

Question 2

What is the key aspect of alternative investing when evaluating the potential effectiveness of an investment strategy?

Answer 2

The key aspect of alternative investing when evaluating the potential effectiveness of an investment strategy is to determine whether the strategy is based on normative reasoning, positive reasoning, or a combination of both. Normative reasoning involves making judgments about what should be done, while positive reasoning focuses on what is likely to happen based on data and evidence.

Question 3

Define normative economic models and their usefulness in financial decisions.

Answer 3

Normative economic models help explain underlying forces that might drive rational financial decisions under idealized circumstances and, to a lesser extent, under more realistic conditions.

Question 4

How can normative approaches be used in trading strategies?

Answer 4

Normative approaches can be used to identify the potential mispricing of securities by identifying how securities should be priced.

Question 5

What is the fundamental aspect of a trading strategy that should be understood?

Answer 5

Whether the strategy is based on normative reasoning or positive reasoning, or both.
Normative reasoning involves making decisions based on what should happen, while positive reasoning involves making decisions based on what is likely to happen.

Question 6

What are arbitrage-free pricing models?

Answer 6

Arbitrage-free pricing models are normative models that describe relationships should hold given that the actions of arbitrageurs will eliminate arbitrage opportunities.

Question 7

Give an example of a normative strategy based on put-call parity.

Answer 7

A normative strategy based on put-call parity is a strategy that follows the principle of put-call parity to determine the fair value of options. This strategy involves buying a call option, selling a put option, and holding the underlying asset. By doing so, investors can take advantage of any mispricing in the options market and potentially earn a risk-free profit.

Question 8

What do positive economic models try to do?

Answer 8

Positive economic models try to explain past behavior and then predict future behavior. These models are based on empirical data and focus on describing and analyzing economic phenomena without making value judgments. By examining historical patterns and trends, positive economic models help economists and policymakers gain insights into how the economy functions and make informed decisions about future policies and actions.

Question 9

What are technical trading strategies based on?

Answer 9

Technical trading strategies are based on analyzing historical price and volume data of financial instruments. Traders use various technical indicators and chart patterns to identify trends, support and resistance levels, and potential entry and exit points. These strategies assume that past price patterns and market behavior can provide insights into future price movements. By using technical analysis, traders aim to make informed decisions about buying or selling assets.

Question 10

Give an example of a positive strategy.

Answer 10

A positive strategy is one that focuses on identifying and capitalizing on opportunities for growth and success. Point-and-figure charts are a type of technical analysis tool that can help traders identify trends and potential entry and exit points in the market.

Question 11

What does alternative investment analysis use?

Answer 11

Alternative investment analysis uses both normative and positive modeling. Normative modeling involves making judgments and recommendations based on subjective criteria, while positive modeling focuses on objective data and analysis

Question 12

How should the effectiveness of models be judged?

Answer 12

The effectiveness of models should be judged based on their ability to predict the future, rather than solely on the reality of their assumptions or their ability to explain the past.

Question 13

How should the effectiveness of models be judged?

Answer 13

The effectiveness of models should be judged based on their ability to predict the future, rather than solely on the reality of their assumptions or their ability to explain the past.

Question 14

Are normative and positive models both useful in understanding and predicting future behavior?

Answer 14

Normative models are based on idealized assumptions and prescribe how people should behave. Positive models, on the other hand, describe how people actually behave. Both types of models have their uses in understanding and predicting future behavior. Normative models provide a benchmark for evaluating behavior and can guide individuals or organizations towards desired outcomes. Positive models, on the other hand, provide insights into the actual behavior of individuals or groups, which can be valuable for making predictions and informing decision-making.

Question 15

Describe the difference between theoretical and empirical modeling.

Answer 15

Theoretical models use deduction and assumptions to describe behavior, while empirical models are based on observed behavior.

Question 16

Explain when theoretical models are more effective in explaining and predicting behavior.

Answer 16

Theoretical models are more effective in explaining and predicting behavior in simplified situations because they allow for a clear understanding of the relationships among variables. In complex situations, there may be numerous factors at play, making it difficult to accurately predict behavior.

Question 17

When are empirical models more effective in explaining complex behavior?

Answer 17

Empirical models are effective in explaining complex behavior when there is a large amount of data available. This is because empirical models rely on data to make predictions and understand patterns. Additionally, empirical models are more effective when the behavior of variables is consistent or changing in predictable ways.

Question 18

Why do alternative investments tend to lend themselves more to empirical models?

Answer 18

Alternative investments tend to be characterized by illiquidity, changing risks, dynamic strategies, or other complexities that can make theoretical modeling impractical.

Question 19

What is the distinction between applied and abstract approaches in research methods?

Answer 19

Applied approaches focus on practical implementation and real-world scenarios, while abstract approaches are more theoretical and conceptual.

Question 20

What are applied models designed to address?

Answer 20

Applied models are designed to address immediate real-world challenges and opportunities. These models are practical tools that can be used to analyze and solve complex problems in various fields such as business, economics, engineering, and social sciences.

Question 21

What are applied models designed to address?

Answer 21

Applied models are designed to address immediate real-world challenges and opportunities. These models are practical tools that can be used to analyze and solve complex problems in various fields such as business, economics, engineering, and social sciences.

Question 22

Give an example of an applied model.

Answer 22

Markowitz’s model, also known as Modern Portfolio Theory, is a widely applied model in finance. It helps investors make decisions about asset allocation and diversification by considering the trade-off between risk and return. The model quantifies the relationship between different assets and their potential impact on a portfolio’s overall risk and return.

Question 23

What are abstract models also called?

Answer 23

Basic, conceptual models or high-level models. These models provide a simplified representation of a system or process, focusing on the key concepts and relationships rather than specific details. They help in understanding and communicating complex ideas in a more manageable way. Provide a fundamental understanding of a system or concept.

Question 24

How are abstract models different from applied models?

Answer 24

Abstract models and applied models differ in their level of realism and practicality. Abstract models are more theoretical and are used to explain hypothetical behavior in less realistic scenarios. They focus on general principles and concepts rather than specific real-world applications.

Question 25

What do cross-sectional models analyze?

Answer 25

Relationships across characteristics or variables observed at a single point in time.

Question 26

What do time-series models analyze?

Answer 26

Behavior of a single subject or set of subjects through time.

Question 27

What is a panel data set?

Answer 27

A panel data set is a type of dataset that contains information on multiple subjects or entities observed over multiple time periods.

Question 28

Give an example of a panel model.

Answer 28

Analyse the returns on Real Estate Investment Trusts (REITs) using a REIT index over time

Question 29

Describe the purpose of a time-series model in investment analysis.

Answer 29

A time-series model helps researchers understand how average REIT returns are explained in terms of various market factors.

Question 30

What is the purpose of a cross-sectional in investment analysis?

Answer 30

A cross-sectional model is used to explain why the long-term average returns of various REITs differ by regressing the returns against variables such as geographic region, property type, and leverage.

Question 31

Explain the concept of a panel study in investment analysis.

Answer 31

A panel study involves putting all the short-term returns for each time period and each REIT into a single data set and econometric model.

Question 32

What is the focus of autoregressive conditional heteroskedasticity (ARCH) and generalized autoregressive conditional heteroskedasticity (GARCH) analyses?

Answer 32

ARCH and GARCH analyses focus on the time-series behavior of an asset’s unexplained return volatility and potential patterns in the variance of unexplained return.

Question 33

Why is understanding investment analysis methodology important?

Answer 33

Understanding investment analysis methodology helps organize and compare investment strategies, evaluate different approaches, and assess the prospects for investment success.