- Growth in Structured Securities
- Growing Emphasis on Low Volatility and Dividends
- Criticisms of Structured Securities
- Demand for Quantitative Skills
- Direction of Quantitative Finance
- When I Realized It Might Be Easier
- Try Again
- The Spreadsheet
- Visualizing the Result
- What It Means and Why It Works: A Nontechnical Overview
- It Doesn't Get Too Complicated
- An Integrated View of Risk Management
Try Again
That night at Starbucks, I decided to try again. Something was nagging at me. A piece was missing. I knew that volatility affects stock price simulations. The more volatile, the more the distribution of prices is dragged down. But I had not included anything in this spreadsheet to account for that.
I was aware of the fact that, in Monte Carlo simulations, adjustments are made to the distribution being sampled so that returns are not overstated. I wondered if that was what I needed to add.
I went back to the book. On page 597, McDonald said:
- [W]e need to subtract 1/2 times the variance.
That was the term I had been thinking about.
I wrote the following on a napkin:
- Mean − 1/2 variance = 0.0% − 0.5 × 0.302 = 0 − .5 × .09 = –0.045 = –4.5%
Worth a shot. So I plugged that into the spreadsheet.
It worked. Then I tried using different assumptions, and it still worked. I still thought it was too easy to be right, but this time I couldn’t show that it was wrong.