This thread is intended to be a serious version of http://elitetrader.com/vb/showthread.php?t=227873 without the flame war. So I think we all understand (due to atticus' quote, and sle, and others...) that you need to have some kind of edge in predicting vol and/or direction to be profitable. My question is, how do you guys do it? I am not asking for the keys to the castle, but what sort of modeling approach do you take? - Is Sinclair right that every options trader basically thinks of the world as a GARCH model? - Do you extend this to integrated/fractionally integrated processes? - Do you only model vol? It seems a common assumption that drift is zero (e.g., through the use of log returns), and therefore every move is vol, but I find that hard to believe in some cases. - How do you model correlations/dependence between names? - How do you cap the number of lags/meaning of lags when the data are higher frequency? - Are there a few key insights or key academic papers that lay out a useful model selection process? (i.e., a process that avoids over-fitting) - Perhaps most important, what sort of predictions are we looking for the model to make? That vol relationships between names will mean revert? That skew/term structure in one name will converge to a long term relationship? On a related note, do you find that markets are sometimes predictably mean-reverting? Based on a model of markets as a continuous-time bidding/auction process, it seems to me they would have to be, save for a percentage of market participants acting on trend-following strategies. If so, it would seem that no-arbitrage arguments require all options to be overpriced from a directional betting perspective, because mean-reversion would make their delta-hedged value higher than their value based on the distribution of prices at expiry. If we are comparing delta-hedged replication vs. distribution of terminal prices, then drift now plays a role, too. Thoughts? mj
I have to laugh!!!! "Beware of geeks bearing formulas" .....................Warren Buffett The market ultimately is not about GARCH models... it's about mothers buying diapers at Walmart.
The market is ultimately about making money. If GARCH models work for you, good. If something else does, good for you.
http://www.amazon.com/The-Quants-Whizzes-Conquered-Destroyed/dp/0307453383 http://www.amazon.com/When-Genius-Failed-Long-Term-Management/dp/0375758259 How soon we forget. "The market is ultimately about making money" No it isn't. The market is ultimately about providing capital to grow the economy and getting paid a fair price for your investment. It's the leaches like us who pervert that and ultimately destroy it with our greed.
The fact that a few greedy idiots managed to overleverage themselfs and blow up does not really prove anything (if anything, they have done very well for themselfs, it's the investors that were left holding the bag). I have been making money (almost certainly more then you make using your strategy) using quantitative methods for many years (probably longer then you ) and never had a losing year. So, what does that prove? Don't kid yourself, market is about greed. Capitalism is about greed. It's horrible but it's true.
"Don't kid yourself, market is about greed. Capitalism is about greed. It's horrible but it's true" It's only true if we make it so. Life is not about who dies with the most toys. It's about having made a contribution to civilization... or should be. Also: I don't believe the real problem was 'overleveraging' so much as the delusion that the equations really described physical reality at a basic level.... which they don't.
Well, with my education I could have been building nuclear weapons, powerplants but I ended up trading financial weapons of mass destruction. If anything, I have contributed
"I have contributed" Baloney. We contribute nothing. We suck as much blood out of the economy as we can get and piss it away on mcmansions and cars. Disgusting.
We can all work together here Greed applied in efficient, competetive markets, is what leads to wealth creation, capital formation, price discovery and a better life for all. Problems occur when greed is applied outside of that context, under asymmetric information or failing markets. But I don't think any "elitetraders" make their money pushing products designed to fail on clueless old ladies, so it's all good. If you make millions trading ES, I have nothing but the greatest respect for you, for being able to extract money from such an efficient market. That is the true spirit of capitalism.