In the world of Finance and Investment, there are indeed many given ways to succeed. Where Warren Buffet suggests value investing, meanwhile many people believe trading is the way to go, holding on to securities for short periods of time before selling them off again.
Ed Thorp - arguably the father of mathematics within finance was a maths professor at MIT in the 1950's and was obsessed with probabilities. He soon applied his interests to the game of black jack and managed to crack it, writing a book "Beat the Dealer". Later there was a movie about him - has anyone not seen '21'? Later on in life, he used the same principles to make millions of dollars on Wall Street, he was the first 'quantitative analyst'. Ed Thorp made a few conclusions, namely the market follows a Brownian Motion - completely unpredictable. It was also described as a random walk - a stock or bond will rise or fall is as likely as getting a heads on a coin toss (50%).
Thorp applied his statistical formula's to warrants and quantified their beta (volatility), thus he looked for mispriced warrants where the price has underestimated or overestimated its beta and deduced money can be made.
Over the following years, many 'Quants' have come and gone. John Meriwether and Long Term Capital Management has fallen in style due to too much leverage. Ken Griffin, manager of Citadel Investment Group had a great run before the crash of 2008.
Then there is Renaissance Technologies and its flagship Medallion Fund, with returns of roughly 40% a year for 3 DECADES!!! Many claim this fund as found 'The Truth' or 'Alpha'.
The fund was headed by James Simons, a man who did his undergraduate degree at MIT and sailed through his Masters Programme - all in mathematics. He recruited the top people for the job, from cryptanalysts to computer science wizards.
They used the hidden Markov process model to calculate probabilities in a sequence of events that have no direct relation to one another - a kind of random walk with random variables that change along the way. Nobody knows precisely how they do it, but Simon's once remarked 'patterns of price movements are not random' - hence his supercomputers sift through data for identifiable patterns in prices. The fund also always tweaks its models, accounting for a change in the fundamentals more often than most other quant operations.
It seems many people have different theories on how to find 'The Truth'. Many people have had a good short term run but inevitably have crashed. It seems the funds or companies that last in the volatile world of finance and investment are statistical anomalies - like Buffet or Simon's.
It begs the question, is there a hidden truth to financial markets? Is there an Alpha?
The Young Economist
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