Equity Valuation and Portfolio Management

KEY POINTS

• Despite mainstream academic opinion equity markets are efficient, there is a growing body of evidence that there are market anomalies that can be systematically exploited to earn excess profits after considering risk and transaction costs.
• The technological advances in computing power have tempted investors to use machines to make investment decisions. In the process of doing so, it is easy to lose sight of the essence of human knowledge required in any good decision making process.
• In evaluating models for potential implementation of investment strategies, two guiding principles are model simplicity and out-of-sample validation. We can place a higher level of confidence on a simple model validated on data different from those on which it has been built.
• In the quantitative process the identification of any persistent pattern in the data is sought and must then be converted it into implementable and profitable investment strategies. How this is done requires the development of underlying economic theories, an explanation of actual returns, estimation of expected returns, and construction of corresponding portfolios.
• For backtesting proposed strategies, the sample used can be a set of observations that have been preselected through time by some common denominators. Although a sample of a sample should not pose a problem in backtesting if the subset is selected randomly, this is not the case for most samples that suffer from survivorship bias. A statistically significant ...