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Old 08-27-2017, 10:44 AM
Latitude30 Latitude30 is offline
Join Date: Feb 2012
Posts: 2,499
Default I think Exam MFE core concepts are due for revisions

Topic bullet point needing revision : Modeling of expected returns and volatilities for stock ETFs/mutual funds

Option pricing from discounting with risk neutral probabilities would still be the same. As would be option pricing from known stock return and volatility assumptions

Old Myth:

Brownian motion and random walk assumptions are best estimations for all stock-related investments and hence all option derivatives associated with stock price.

More recent Hypotheses and Finds:
Recent trading and investment trends: Investors now are able to purchase numerous affordably low expense-ratio maintenanced ETFs, pairing numerous stocks together in equity classes that contain an index-matched price, such as SPY, EFA, IWM, EEM, etc.
With the diffusing from Alpha company-specific risks, the movement of price though logarithmic, is a far cry from a "random walk" with a constant sigma volatility and an evergreen annual return rate, as these probabilistic principles dictate otherwise.

1) Upward motion tends to exceed 50% probability when price holds above the 200-day moving average trend line and/or the 200-day moving average trend line is upward sloping, and/or the 50-day moving average is above the 200-day, and vice versa. The probability skews when an alignment of these is present in a single direction, and less skewed given a mixed bag.

2) Unbiased volatility is skewed by the presence of Fib retracements which examine price points where stock movements gravitate on "golden ratio of A to B moves". These patterns govern both bear market and bull market trends and are more predictable than a random walk Monte Carlo simulation.

3) Long periods of consolidation in stock rates of return, followed by moving outside the box of upper and lower range, results in Expected fund future volatility much higher than the historical volatility (the longer the consolidation period before moving out of the box, the bigger the move up or down).

4) 1, 2, and 3 above have been shown to apply no differently on a minute chart, daily chart, weekly chart, monthly chart, or even multi-year chart as far as market fractals observed for any composite of stocks, with moving average thresholds adjusted accordingly to time scale of investor's choosing.
(Shorter-term investors strive for maximizing precision of getting short-term movements as accurately as possible at the expense of potentially undergoing some unnecessary position trades over the longer haul, while longer term investors increase odds of capturing longer term moves by absorbing shorter term risks due to normal volatility by initiating fewer re-allocations over time.

(Transactions always have an associated cost in form of either restrictive penalty rules, fees, or fund expense setting. Fund Expense setting itself is an interesting potential prelim topic. It's balancing the cost risk resulting from users of a fund excessively trading to maximize each their own returns, against the cost to the entire fund making it relatively more expensive to maintain. Goals of keeping the fund marketable with low expense ratios can require mitigating tactics such as fund restrictions or individual fees for trading in and out.) - good prospective topic add to MFE I think.

Last edited by Latitude30; 08-27-2017 at 03:15 PM..
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