Because the Sharpe ratio only takes into account the first two moments, it wrongly “translates” skewness and excess kurtosis into standard deviation.As a result: It deflates the skill measured on “well-behaved” investments (positive skewness, negative excess kurtosis). It inflates the...

The problem of capital allocation to a set of strategies could be partially avoided or at least greatly simplified with an appropriate strategy approval decision process. This paper proposes such a procedure.We begin by splitting the capital allocation problem into two sequential stages:...

Portfolio optimization is one of the problems most frequently encountered by financial practitioners. To our knowledge, the Critical Line Algorithm (CLA) is the only algorithm specifically designed for inequality-constrained portfolio optimization problems, which guarantees that the exact...

We evaluate the probability that an estimated Sharpe ratio exceeds a given threshold in presence of non-Normal returns. We show that this new uncertainty-adjusted investment skill metric (called Probabilistic Sharpe ratio, or PSR) has a number of important applications: First, it allows us to...

* It has been estimated that the current size of the asset management industry is approximately US$58 trillion.* Portfolio optimization is one of the problems most frequently encountered by financial practitioners. It appears in various forms in the context of Trading, Risk Management and...

Order flow is toxic when it adversely selects market makers, who may be unaware they are providing liquidity at a loss. We present a new procedure to estimate flow toxicity based on volume imbalance and trade intensity (the VPIN toxicity metric). VPIN is updated in volume-time, making it...

Recently Andersen and Bondarenko posted a paper on SSRN with the title “VPIN and the Flash Crash” which is essentially a comment on our earlier work on the measure of order toxicity, VPIN. Andersen and Bondarenko dispute our empirical findings and argue that VPIN essentially doesn't work. We...

Multiple empirical studies have shown that Order Flow Imbalance has predictive power over the trading range.The PIN Theory (Easley et al. [1996]) reveals the Microstructure mechanism by which:– Market Makers adjust their trading range to avoid being adversely selected by Informed Traders.–...

The ‘flash crash' of May 6th 2010 was the second largest point swing (1,010.14 points) and the biggest one-day point decline (998.5 points) in the history of the Dow Jones Industrial Average. For a few minutes, $1 trillion in market value vanished. In this paper, we argue that the ‘flash...

One of the fundamental shortcoming of the popular analysis tools for time series is that they require the data to be taken at uniform time intervals. However, the real-world time series, such as those from financial markets, are mostly from irregular time intervals. It is a common practice to...