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By Tai, September 2, 2010 9:57 am

and Share and

It is well argued that idiosyncratic risks are not desired and can be diversified away (Bodie et al 2007). While this knowledge dominates introduction to finance courses (subjects/modules), idiosyncratic risk is in other most circumstances the key to wealth.

Firm-specific and industry-specific characteristics are key to capture excess returns from CAPM expected return. For example, retail industry, food industry, metal industry etc. fluctuate to business cycles, and business cycles are not captured in CAPM.

Next, idiosyncratic volatility is useful for speculation purpose, especially when you do not have a concrete target on where to exit the investment. Volatile means holding through (or even shorting during) dip and exit during peaks. You earn steady income through dividends and small gains on stable stocks, but you make fortune on volatile-but-fundamentally good investments.

Treynor Black model for alpha specifies that on the Single Index Model

Active portfolio A should receive investment weight

where the rest of the portfolio should be invested in market index. This is one example in the academic world where idiosyncratic is, indeed, good.

Practical relevance: for smaller stocks and international investments, particularly emerging markets, ‘beta’ approach almost does not work. These are the cases where idiosyncrasy comes to play.

Bodie Z, Kane A, Marcus A, 2007, ‘Investments’, McGraw-Hill, 2007

Treynor, J. L. and F. Black, 1973, ‘How to Use Security Analysis to Improve Portfolio Selection’, Journal of Business, January, pages 66–88

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By Tai, August 31, 2010 10:32 pm

and Share and

• Lack of supply drives company value to $33.7b
• Right of first refusal is detrimental to company shareholding when capital structure changes and/or venture capitalists exit
• Speculation is again hype-driven
• My personal forecast is that post-IPO price will rise despite current craze in the secondary market

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By Tai,

and Share and

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By Tai, August 23, 2010 7:39 pm

and Share and

• One-day loss for Intel is 3.52%, one-day return for McAfee is 57.07%
• Considering the trend, the loss for Intel was rather low, indicating that market punishment was not as severe for acquisition of unrelated (software) business
• My speculation is that perhaps the market was expecting a deal from Intel, as signaled by high trading volume and declining stock price prior to the announcement
• The high return on MFE signals significant liquidity motivation to exit the company
• INTC listing NASDAQ might have reduced the loss while MFE listing on NYSE might have increased the gain
• My speculative view on strategy of the deal: apart from hardware security, Intel now has access to cloud security which can be used to offer complementary service to key cloud service providers i.e. Amazon, Salesforce… This strengthens Intel’s alliance beyond the long-standing one with Microsoft (which is currently lost in the cloud). Then what can would Intel do with an alliance? War against Apple?
• Addendum: market reaction is favorable for Intel, signaling good corporate governance

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By Tai,

and Share and

Proving of Fundamental Lemma by Fields Medalist Professor Ngo Bao Chau, or more generally, a breakthrough B in Mathematics theory does have direct impact on everyday life:

1. Research B’, B”, Bⁿ ‘ will spawn
2. Academic components will be composed en masse basing on B, B’…
3. (2) generates billions of revenue for education service providers
4. (2) generates revenue for book composers, sellers and distributors
5. Non-B research will likely cease and research budget will be saved
6. Scientists from other disciplines (Physics, Chemistry, Biology, Computer Science, Anthropology…) will benefit from B
7. Quants will use B to build new financial models, instruments, institutional models… which will lead to new cycles of fund flows, transfer of wealth, job creation, excessive expansions… All will feed up bubbles which test limits of economic systems. When the limits are smashed, markets will crash and economies will collapse (Ho 2010). A few extraordinary quants (Doan 2010) equipped with mathematics beyond normal human comprehension and possess real understanding of behavioral economics will make fortune; hundreds of thousands will lose their jobs and assets; billions will suffer crises.
8. Perhaps the most well-known example of (7) in Finance world is Ito’s lemma and Wiener process, used for Derivatives valuation ⁽ⁱ⁾ (Ho 2010). Derivatives market beyond control is one reason which had lead to 2007-present global financial crisis ⁽ⁱⁱ⁾ (Friedman & Friedman 2009).

B might be rooting it all. At this very present.

(i) John Hull - Options, Futures, and Other Derivatives, Seventh Edition http://www.rotman.utoronto.ca/~hull/ofod/

(ii) Hershey H. Friedman & Linda W. Friedman - The Global Financial Crisis of 2008: What Went Wrong? http://ssrn.com/abstract=1356193

Image from Wolfram’s demonstration of Ito’s Lemma