Showing papers by "Robert D. Arnott published in 1988"

The risk premium and stock market performance

Abstract: 50 3 M arket events of the past ten years have 8 ? sparked an interest in tactical asset allocation, the dignified new title for market timing. The turbulence of October 1987 has only accelerated this interest. In the typical ,application, the portfolio manager seeks to assess the trade-offs between the expected return and risk of various asset classes, such as stocks, bonds, and cash. There are a myriad of techniques used, including valuation analysis, investor sentiment analysis, volatility analysis, and so on. Here we examine the equity risk premium as a key component of the asset allocation decision. Our purpose is to test the predictive value of various equity market risk premium proxies. To do this we conduct statistical tests to determine if the risk premium proxy, measured in any month, is directly correlated with subsequent market returns in the following month. The results are encouraging, suggesting the following: @ Earnings yield and dividend yield are very effective tools for asset allocation. Indeed, they outperform the constant growth dividend discount model (DDM) approach, at least in this narrowly defined context. Q The earnings yield approach can be improved substantially with appropriate attention given to some of the quirks of the earnings stream. Q In aU fairness, even the best of these disciplines can be enhanced by including additional information. lJnfortunately, much of the ”additional informaiion” is not subject to quantification. By combining various techniques, we can produce an “equity excess return predictor,” which turned bearish three months before the October crash.

The future for quantitative investment products

Abstract: B practice, we have seen a proliferation of new products, new strategies, and even new investment assets. Along with these new products, new strategies, and new assets, the role of the pension sponsor is changing, the role of the investment manager is changing, and the state of investment theory is changing. This article is an attempt to step back from the specifics in order to explore the implications of all this change for the investment world of the 1990s. My principal focus is on the quantitative arena, for most of the growth in our industry in the past decade (and most growth in the coming decade) stems directly from the strides made in quantitative theory and application. What is quantitative investment management, anyway? Quantitative investment management is more a matter of process than anything else. The differentiating feature is that the quantitative manager lets the computer do the dirty work in finding issues that have certain target characteristics. The process forces the portfolio managers to reflect the disciplines that they purport to use. The quantitative process minimizes slippage. A quantitatively derived portfolio cannot fail to match the intended portfolio characteristics. Three additional facts need emphasis: 1. First, quantitative investment management does not guarantee success. A bad discipline, quantitatively implemented, will perform badly. Indeed, it may do worse than a similar quaIitative process, because there will tend to be less slippage. 2. Second, there is no de facto basis for believing that a quantitative approach is superior to a qualitative approach. 3. Third, as more investors engage in quantitative investment management, a historically effective discipline will not suffice, The quantitative manager must have a disciplined process that is superior to other investment approaches, including other quantitative approaches. Therein lies today’s challenge. It is no longer enough to be a quant. It is necessary to be a better quant.