Comments on: Predicting alpha: Not that hard after all finds new study http://allaboutalpha.com/blog/2009/01/22/predicting-alpha-not-that-hard-after-all-finds-new-study/ A finance blog about hedge funds, portable alpha and alternative investing. Mon, 13 Feb 2012 11:26:54 +0000 http://wordpress.org/?v=abc hourly 1 By: Denise Shull http://allaboutalpha.com/blog/2009/01/22/predicting-alpha-not-that-hard-after-all-finds-new-study/comment-page-1/#comment-150865 Denise Shull Tue, 27 Jan 2009 13:42:59 +0000 http://allaboutalpha.com/blog/?p=4119#comment-150865 "This is a pretty significant finding since it suggests that markets are not perfectly efficient - maybe not even “semi-efficient”. In fact, they appear from this study to be predictable based solely upon prior returns." -- Not to be argumentative but the question of markets not being efficient isn't truly in doubt, is it? "The predictive relationship between r-squared and alpha also works in reverse, say the authors of this paper. Funds with high alpha performance one year tend to have a low r-squared values the next. The authors suggest this may be because…“…funds with exceptionally good performance in one year tend to take idiosyncratic bets in the following year because they can ‘afford it’ given past success and given that funds are usually judged over a number of years…” " --- this is essentially the same as the neuroeconomically demonstrated 'house money effect'. The actual psychological mechanism in place is a greater feeling of confidence that changes the manager's perception regarding the risk of the next bet. Yes they can afford it but it is the feeling of confidence in their judgment that allows the additional risk to be taken. “This is a pretty significant finding since it suggests that markets are not perfectly efficient – maybe not even “semi-efficient”. In fact, they appear from this study to be predictable based solely upon prior returns.”

– Not to be argumentative but the question of markets not being efficient isn’t truly in doubt, is it?

“The predictive relationship between r-squared and alpha also works in reverse, say the authors of this paper. Funds with high alpha performance one year tend to have a low r-squared values the next. The authors suggest this may be because…“…funds with exceptionally good performance in one year tend to take idiosyncratic bets in the following year because they can ‘afford it’ given past success and given that funds are usually judged over a number of years…” ”

— this is essentially the same as the neuroeconomically demonstrated ‘house money effect’. The actual psychological mechanism in place is a greater feeling of confidence that changes the manager’s perception regarding the risk of the next bet. Yes they can afford it but it is the feeling of confidence in their judgment that allows the additional risk to be taken.

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