There is a common problem in finance when it comes to evaluating investment managers’ performance: the factor or skill vs. luck. When a manager performs well over a number of years, it is not clear whether the success can be attributed to the manager’s skill and strategy, or random luck. And vice versa, when a manager performs badly, it can be difficult to pin-point whether it was due to lack of skill, or simply bad luck.
Another factor that is commonly misunderstood in finance is risk. Understanding the differences between risk, volatility, and skew is essential to developing a well-performing trading strategy.
Campbell Harvey studies these phenomena. He is a finance professor at Duke university, and research associate with the National Bureau of Economic Research in Massachusetts. His research papers on these subjects have been published in many scientific journals.
In this episode, Campbell Harvey and Michael Covel discuss risk tolerance, evaluating trading strategies, Harry Markowitz’ classic paper on portfolio selection, and the importance of differentiating between volatility and skew.
In this episode of Trend Following Radio:
- Survivorship bias, and not being fooled by randomness
- Why people with higher risk tolerance experience much higher upsides
- Understanding process vs. outcome
- The difference between volatility and skew
- The importance of recognizing that asset returns are rarely “normally distributed”
- When it is appropriate to apply a general framework, and when it is not
- The Sharpe ratio – is it always relevant?
- Harry Markowitz, Jim Simons, and Nassim Taleb
“These people that are taking a lot of risk, with enough luck, will rise to the top. The person that is risk-averse is stuck in the middle” – Campbell Harvey
Mentions & Resources:
- “Evaluating Trading Strategies” paper by Campbell Harvey
- “Managerial Attitudes and Corporate Actions” paper by Campbell Harvey on risk tolerance in CEOs
- A list Campbell Harvey’s research papers
- Harry Markowitz’ nobel prize winning paper on selecting and optimizing portfolio
- Harry Markowitz interview with Michael Covel
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