Red-Blooded Risk: The Secret History of Wall Street

[Andy Nguyen]

Quantnet received a copy of the book by the author's publisher (Wiley). Aaron Brown is well-known around this part since he has wrote many well-received articles for Quantnet, specially in the area of risk management.

Has anyone read his new book? http://www.amazon.com/gp/product/1118043863/
From the description on Amazon

From 1987 to 1992, a small group of Wall Street quants invented an entirely new way of managing risk to maximize success: risk management for risk-takers. This is the secret that lets tiny quantitative edges create hedge fund billionaires, and defines the powerful modern global derivatives economy. The same practical techniques are still used today by risk-takers in finance as well as many other fields. Red-Blooded Risk examines this approach and offers valuable advice for the calculated risk-takers who need precise quantitative guidance that will help separate them from the rest of the pack.

 

[dstefan]

A copy of the book was ordered for the Baruch MFE Students Library. Aaron's "The Poker Face of Wall Street" is a highly entertaining classic.

 

[bigbadwolf]

I've ordered a copy for myself. And the same question: Has anyone read it? Overall impression?

 

[shawnp]

Have got a few questions on some of the concepts.. would it be appropriate to discuss under this thread?

 

[bigbadwolf]

Have got a few questions on some of the concepts.. would it be appropriate to discuss under this thread?

Why not? Go ahead.

 

[shawnp]

for starters, in Chapter 5, "When Harry met Kelly", table 5.1, where total excess returns for individual commodities for the 1970-2010 is listed: - what I don't get is how the 34.4% portfolio return is calculated. Since the portfolio return is the result splitting money equally between the 7 individual commodities, shouldn't it be just the average of all the 7 commodities' total return? eg if I have 7000 usd, and i split equally and so invest 1000 usd in each, the (excess) return I get should be just what's listed in the last column (1106 (cocoa) + 83 (corn) +... + 217 ), so shouldn't the (excess) return of the portfolio be just the sum of these seven - 7000? Unless there's some sort of annual rebalancing going on? The reason is that if I don't get this part, then I can't understand the rest of the chapter at all.. i get it that the average annual returns are a simple average and we have to apply the geometric average to get the total return for each row, but that's about where my understanding ends..

 

[Sexbomb]

Are the weights of 7 commodities equal in the Portfolio?If Yes,Return should be average
else it should be summation of(weights X Return)[weighted average]

 

[bigbadwolf]

for starters, in Chapter 5, "When Harry met Kelly", table 5.1, where total excess returns for individual commodities for the 1970-2010 is listed: - what I don't get is how the 34.4% portfolio return is calculated. Since the portfolio return is the result splitting money equally between the 7 individual commodities, shouldn't it be just the average of all the 7 commodities' total return? eg if I have 7000 usd, and i split equally and so invest 1000 usd in each, the (excess) return I get should be just what's listed in the last column (1106 (cocoa) + 83 (corn) +... + 217 ), so shouldn't the (excess) return of the portfolio be just the sum of these seven - 7000?

Yes, you rebalance at the end of each year to keep the money equally apportioned among the seven commodities. Otherwise, as you say, the total portfolio return would be just the average of the commodities' total return. By rebalancing, the fact that the standard deviation of the portfolio is less than the mean of the standard deviation of the components kicks in and hence annual return will be higher than either 1) investing in any one commodity, or 2) investing without rebalancing.

 

[shawnp]

Thanks bigbadwolf! That certainly clears things up for staters.. moving on to the 2nd bit on table 5.2, using the same logic of annual rebalancing, i take:

(1) the "optimal investment amount" is also the amount that is invested, rebalanced annually? Then the 85.7% "optimal investment amount" for the Portfolio is whereby you invest 85.7% of the assets equally amongst the 7 commodities and then rebalance annually (so that 85.7% is always invested equally, and the rest in bonds)?

(2) the weights in table 5.3 are the weightings of the commodities you'd take, and rebalanced annually to maintain this weighting, which would yield the highest sharpe ratio for the portfolio. Since they don't sum to 1, i'm assuming the rest is put in bonds.

(3) the optimal 3.322 to 1 leverage means you buy 14.3% * 3.322 of cocoa, -37.1% * 3.322 of corn etc the final weights are more than 100% so the rest is financed by selling bonds.

Would appreciate if you could let me know if i'm thinking straight, thanks alot again!