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Volatility  Surviving or Thriving With New Market Challenges Navellier Applied Research
Volatility Defined Please see important disclosures at the end of the presentation Volatility:  A measure of risk based on...
This is the formula for standard deviation, a common measure for risk. Please see important disclosures at the end of the ...
Will NOT be seen for the remainder of this presentation Rest easy…..let’s discuss some ideas! Please see important disclos...
So what about risk? <ul><li>Recall that standard deviation is a common measure of risk:  </li></ul><ul><li>Low = Good? </l...
Remember what standard deviation is measuring! Degree of  movement from the average Please see important disclosures at th...
Trampoline Thought Experiment <ul><li>Consider the case of two trampolines. </li></ul><ul><li>Trampoline #1:  Soft and yie...
Trampoline Example Of the two, wouldn’t this be the preferred investment manager? Semi standard deviation or “downside ris...
Here is the Trampoline Math Standard Deviation =  Please see important disclosures at the end of the presentation 5 9 -5 -...
Assume equal standard deviation. Which investment is getting riskier?  Less risky? Time Risk Manager “A” Risk is Rising Ma...
Adjusting Returns for Risk <ul><li>Common Standard: </li></ul><ul><li>Sharpe Ratio = </li></ul>Average Return – Risk Free ...
Other Risk Adjusted Return Measures <ul><li>Treynor Ratio </li></ul><ul><li>Treynor Ratio = </li></ul>Average Return – Ris...
Other Risk Adjusted Return Measures - continued <ul><li>Sortino Ratio </li></ul><ul><li>Sortino Ratio = </li></ul>Average ...
Standard deviation and the current “credit crisis” Please see important disclosures at the end of the presentation
Is this the root of the problem? Please see important disclosures at the end of the presentation.  Graphs for discussion p...
“ Deal or No Deal?”  Normal or Not Normal? Twenty Year Histogram of Monthly Index Returns ≠ ≠ Please see important disclos...
Everything hides in the assumptions! A physicist, a chemist and an economist are stranded on an island, with nothing to ea...
“ Let’s assume we have a can opener!” Please see important disclosures at the end of the presentation
Are possible small model errors compounding to result in major disruptions?  Are academic practitioners building financial...
Reality vs. models The standard statistical approach to risk management is based on a “bell curve” or normal distribution,...
Nine standard deviations?  Really? <ul><li>Let’s look at a curve that can be considered accepted as normal:  human height ...
Illustration of financial crisis rarity. Source:  Bloomberg.  Used with permission.  Link:  http://www.bloomberg.com/apps/...
“ If it doesn’t fit, you must acquit.” - Johnnie Cochran <ul><li>“ If the population of price changes is strictly normal, ...
So what? <ul><li>“ Tail risk” may be a significant contributor to unexpectedly large market events.  </li></ul>Please see ...
Other Risk Adjusted Return Measures - continued <ul><li>Alpha </li></ul><ul><li>Alpha = Difference between actual returns ...
R  What? <ul><li>R-Squared: </li></ul><ul><li>Allows a means to measure if you are using an appropriate benchmark when eva...
R  What?  R-Squared Example Not = = Large Growth Manager Russell 1000 Growth Index Large Growth Manager Russell 2000 Value...
R-Squared: Where is the “validity zone?” 70 -75 Below 70 75 - 100 = = Statistics Unreliable. Tip off is that statistical r...
In Summary <ul><li>Risk can take many forms.  </li></ul><ul><li>Standard deviation may not be the best way to measure risk...
<ul><li>Notes: </li></ul><ul><li>1. Navellier & Associates, Inc. is an independent investment management firm established ...
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Surviving Or Thriving 1

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Surviving Or Thriving 1

  1. 1. Volatility Surviving or Thriving With New Market Challenges Navellier Applied Research
  2. 2. Volatility Defined Please see important disclosures at the end of the presentation Volatility: A measure of risk based on the standard deviation of the asset return. Source: Prof. Campbell R. Harvey’s Hypertextual Finance Glossary
  3. 3. This is the formula for standard deviation, a common measure for risk. Please see important disclosures at the end of the presentation
  4. 4. Will NOT be seen for the remainder of this presentation Rest easy…..let’s discuss some ideas! Please see important disclosures at the end of the presentation
  5. 5. So what about risk? <ul><li>Recall that standard deviation is a common measure of risk: </li></ul><ul><li>Low = Good? </li></ul><ul><li>High = Bad? </li></ul><ul><li> Really? </li></ul>Please see important disclosures at the end of the presentation
  6. 6. Remember what standard deviation is measuring! Degree of movement from the average Please see important disclosures at the end of the presentation. Graphs for discussion purposes only.
  7. 7. Trampoline Thought Experiment <ul><li>Consider the case of two trampolines. </li></ul><ul><li>Trampoline #1: Soft and yielding. </li></ul><ul><li>Trampoline #2: Firm and resilient. </li></ul><ul><li>How can they help to illustrate standard deviation? </li></ul>Please see important disclosures at the end of the presentation
  8. 8. Trampoline Example Of the two, wouldn’t this be the preferred investment manager? Semi standard deviation or “downside risk” #1 #2 Please see important disclosures at the end of the presentation. Graphs for discussion purposes only.
  9. 9. Here is the Trampoline Math Standard Deviation = Please see important disclosures at the end of the presentation 5 9 -5 -1 5 9 -5 -1 5 9 -5 -1 5.48 5.48
  10. 10. Assume equal standard deviation. Which investment is getting riskier? Less risky? Time Risk Manager “A” Risk is Rising Manager “B” Risk is Falling Please see important disclosures at the end of the presentation. Graphs for discussion purposes only.
  11. 11. Adjusting Returns for Risk <ul><li>Common Standard: </li></ul><ul><li>Sharpe Ratio = </li></ul>Average Return – Risk Free Rate Standard Deviation of Manager Returns Please see important disclosures at the end of the presentation
  12. 12. Other Risk Adjusted Return Measures <ul><li>Treynor Ratio </li></ul><ul><li>Treynor Ratio = </li></ul>Average Return – Risk Free Rate Beta of Manager to Market Please see important disclosures at the end of the presentation
  13. 13. Other Risk Adjusted Return Measures - continued <ul><li>Sortino Ratio </li></ul><ul><li>Sortino Ratio = </li></ul>Average Return – Risk Free Rate Downside Deviation Please see important disclosures at the end of the presentation
  14. 14. Standard deviation and the current “credit crisis” Please see important disclosures at the end of the presentation
  15. 15. Is this the root of the problem? Please see important disclosures at the end of the presentation. Graphs for discussion purposes only.
  16. 16. “ Deal or No Deal?” Normal or Not Normal? Twenty Year Histogram of Monthly Index Returns ≠ ≠ Please see important disclosures at the end of the presentation. Graphs for discussion purposes only.
  17. 17. Everything hides in the assumptions! A physicist, a chemist and an economist are stranded on an island, with nothing to eat. A can of soup washes ashore. The physicist says, &quot;Lets smash the can open with a rock.&quot; The chemist says, &quot;Lets build a fire and heat the can first.&quot; The economist says……………………………………… Please see important disclosures at the end of the presentation
  18. 18. “ Let’s assume we have a can opener!” Please see important disclosures at the end of the presentation
  19. 19. Are possible small model errors compounding to result in major disruptions? Are academic practitioners building financial models that assume normal distributions? Please see important disclosures at the end of the presentation
  20. 20. Reality vs. models The standard statistical approach to risk management is based on a “bell curve” or normal distribution, in which most results are in the middle and extremes are rare. It is the bell curve to which investors are referring when they talk about a “nine standard deviation event”. But financial history is littered with bubbles and crashes, demonstrating that extreme events or so-called “fat tails” occur far more often than the bell curve predicts. Spooking investors Oct 25th 2007 From The Economist print edition Please see important disclosures at the end of the presentation
  21. 21. Nine standard deviations? Really? <ul><li>Let’s look at a curve that can be considered accepted as normal: human height </li></ul><ul><li>Nine deviations from assumed average = </li></ul><ul><li>1 in 8,900,000,000,000,000,000 </li></ul>Source: Nassim Taleb, The Black Swan , pg 231 Please see important disclosures at the end of the presentation
  22. 22. Illustration of financial crisis rarity. Source: Bloomberg. Used with permission. Link: http://www.bloomberg.com/apps/news?pid=20601109&sid=acw1G8iS8oXc&refer=home -4.04% As of 2/13/09 For Financial Advisor One on One Use Only Please read important disclosures at end of presentation.. Graphs are for discussion purposes only. Number of standard deviations
  23. 23. “ If it doesn’t fit, you must acquit.” - Johnnie Cochran <ul><li>“ If the population of price changes is strictly normal, on average for any stock…….. an observation more than five standard deviations from the mean should be observed about once every 7,000 years. In fact such observations seem to occur about once every three or four years ” – Eugene Fama, Journal of Business , January 1965 </li></ul><ul><li>Under the assumption of normal return distributions, the probability of the October 1987 crash was so remote that according to efficient market theory it would have been virtually impossible – Jackwerth and Rubinstein, Journal of Finance , Vol 51 1996 </li></ul><ul><li>“ The problem for traders is that it is much more complicated to create models for a world of fat tails than for a world of bell curves . As a result, traders repeatedly get caught out by “unprecedented” market movements. The collapse of two hedge funds, Long-Term Capital Management in 1998 and Amaranth Advisors in 2006, were cases in point” – The Economist , October 18 th 2007. </li></ul>The “Fatter” the distribution tails, the less reliable the statistics ! Please see important disclosures at the end of the presentation
  24. 24. So what? <ul><li>“ Tail risk” may be a significant contributor to unexpectedly large market events. </li></ul>Please see important disclosures at the end of the presentation
  25. 25. Other Risk Adjusted Return Measures - continued <ul><li>Alpha </li></ul><ul><li>Alpha = Difference between actual returns and expected returns given a certain level of risk. The higher the better. </li></ul><ul><li>Assumptions include: </li></ul><ul><li>a: market risk, as measured by beta is the only risk measure needed </li></ul><ul><li>b: R-squared is valid </li></ul>Please see important disclosures at the end of the presentation
  26. 26. R What? <ul><li>R-Squared: </li></ul><ul><li>Allows a means to measure if you are using an appropriate benchmark when evaluating a manager or fund. If so, MPT statistics are valid. </li></ul>To Not = = Please see important disclosures at the end of the presentation
  27. 27. R What? R-Squared Example Not = = Large Growth Manager Russell 1000 Growth Index Large Growth Manager Russell 2000 Value Index Small Value Benchmark Large Growth Benchmark Please see important disclosures at the end of the presentation
  28. 28. R-Squared: Where is the “validity zone?” 70 -75 Below 70 75 - 100 = = Statistics Unreliable. Tip off is that statistical results appear strange. Statistics Valid. Please see important disclosures at the end of the presentation
  29. 29. In Summary <ul><li>Risk can take many forms. </li></ul><ul><li>Standard deviation may not be the best way to measure risk. </li></ul><ul><li>Most risk models assume a normal distribution of returns in order to generate probabilities of downside risk. </li></ul><ul><li>Be aware that “fat tails” may exist in assumptions used to gauge risk. Thus, risk may be more extreme than originally assumed. </li></ul>Please see important disclosures at the end of the presentation
  30. 30. <ul><li>Notes: </li></ul><ul><li>1. Navellier & Associates, Inc. is an independent investment management firm established in 1987. Navellier & Associates, Inc. manages a variety of equity for primarily U.S. and Canadian institutional and retail clients. </li></ul><ul><li>Data is subject to change over time. </li></ul><ul><li>Data has been obtained from sources believed to be reliable but there is no guarantee of completeness or accuracy. </li></ul><ul><li>None of the information presented herein constitutes a recommendation by Navellier or a solicitation of any offer to buy or sell any securities. INFORMATION PRESENTED IS GENERAL INFORMATION THAT DOES NOT TAKE INTO ACCOUNT YOUR INDIVIDUAL CIRCUMSTANCES, FINANCIAL SITUATION OR NEEDS, NOR DOES IT PRESENT A PERSONALIZED RECOMMENDATION TO YOU. Although information has been obtained from and is based upon sources Navellier believes to be reliable, we do not guarantee its accuracy and the information may be incomplete or condensed. </li></ul>Disclosures

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