Quantitative Portfolio Management

Introduction

Science is what we understand well enough to explain to a computer. Art is everything else we do.

Donald Knuth

Financial investment is a way of increasing existing wealth by buying and selling assets of fluctuating value and bearing related risk. The value of a bona fide investment is expected to grow on average, or in expectation, albeit without a guarantee. The very fact that such activity, pure gambling aside, exists is rooted in the global accumulation of capital, or, loosely speaking, increase in commercial productivity through rational management and technological innovation. There are also demographic reasons for the stock market to grow—or occasionally crash.

Another important reason for investments is that people differ in their current need for money. Retirees have accumulated assets to spend while younger people need cash to pay for education or housing, entrepreneurs need capital to create new products and services, and so forth. The banking and financial industry serves as an intermediary between lenders and borrowers, facilitating loans, mortgages, and municipal and corporate bonds. In addition to debt, much of the investment is in equity. A major part of the US equity market is held by pension funds, including via mutual funds holdings.¹ Aside from occasional crisis periods, the equity market has outperformed the inflation rate. Stock prices are correlated with the gross domestic product (GDP) in all major economies.² Many index and mutual funds ...