The Prayer — Ten-Step Checklist for Advanced Risk and Portfolio Management
I recently came across Attilio’s ‘The Prayer’ in both his MathWorks webinar and its associated PDF and, though I have found it rather mathematically daunting, I can certainly appreciate its meticulous consideration of the rigours of quantitative finance. It can be found here:
Of particular interest to me are its first four parts, namely Quest for Invariance, Estimation, Projection and Pricing. Is it possible to apply the concepts described in the paper to the currency market, given that it is a zero-sum game?
If it is possible to apply these concepts to FX, what form would the invariants take? Would, for example, they be comprised of the trader’s own trading rules, incorporating such things as momentum and mean-reversion factors?
I’d be grateful for any advice or comments on how to apply those first four steps to the currency market.
The risk drivers of an asset class and the signals of a strategy are two different concepts. In particular, the risk drivers depend on the market, but not on the trader, whereas the signals are specific of the trader.
In FX, the most natural risk driver is the log-spot rate, and first-order invariants are its differences. Estimation can be done via a very simple empirical distribution of the differences. Projection is not necessary if the estimation step is the same as the investment horizon, say one day. Pricing is the simple exponential, which maps log-differences into next-day linear returns.
Signals such as momentum or reversal are meant to capture a predictive influence on the expectation of the linear returns. To convince themselves of the existence of such predictability, people typically run backtests.
“To convince themselves of the existence of such predictability, people typically run backtests” tells a lot about the risk of a psychological bias in running backtest, am I right? I mean, is this your opinion about? Regards
NOTE I now post my TRADING ALERTS into my personal FACEBOOK ACCOUNT and TWITTER. Don't worry as I don't post stupid cat videos or what I eat!