By Mark P. Kritzman
Monetary pros are confronted with more and more technical issues which are theoretically complex yet essentially worthwhile in identifying the trade-off among threat and go back. The transportable monetary Analyst, moment version is a special selection of essays that deal with the guts of each analyst's and investor's problem: the right way to make judgements within the face of unknown forces and the way to claim a few regulate over the end result
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Extra resources for The Portable Financial Analyst: What Practitioners Need to Know, 2nd Edition
It is also possible to generate the return distribution of an option strategy or a dynamic trading strategy based on just the mean and variance of the risky asset. We ﬁrst generate the risky asset’s return distribution under the assumption of lognormality. Then we map the risky asset’s returns onto the option strategy’s returns according to the terms of the option contract. Consider a protective put option strategy, for example. For a risky asset return at or above the strike price, we calculate the option strategy’s return as the risky asset return net of the option premium.
3075). The distribution of compounded returns, therefore, is positively skewed. 00 percent, and its periodic returns are generated by a normal distribution rather than a lognormal distribution. Also, suppose we select 100 random returns for 10 consecutive periods from this normal distribution. qxd 7/25/03 11:08 AM Page 44 44 HIGHER MOMENTS samples of 100 returns, along with the same statistics for the compounded 10-year cumulative returns. 00 percent for skewness, because they simply reﬂect sampling error.
Given risk aversion equal to 5, we would prefer the less risky asset. 7 percent. In this case, the incremental expected return of the second asset is sufﬁcient to counter its higher risk. 3 summarizes these results. It is possible to identify combinations of expected return and standard deviation (the square root of variance) that yield the same level of expected utility for a particular risk aversion coefﬁcient. 4 shows several combinations based on risk aversion of 4. It indicates we are more inclined to incur risk in order to increase expected return at lower levels of expected return than we are at higher levels of expected return.