Inputs and Decisions in Simulation
Historical Simulation Historical simulation employs randomness by drawing returns from historical data randomly, instead of following each period chronologically. An election can be made on whether to sample from the historical returns with or without replacement. Analysts prefer drawing samples…
Simulation Analysis
Simulation provides a complete picture when backtesting because it accounts for the dynamic nature of financial markets, which carry extreme downside and upside risk. The basic types of simulation are historical simulation and Monte Carlo simulation. Historical simulation involves the…
Historical Scenario Analysis
Historical scenario analysis is a form of backtesting that examines the risk and performance of an investment strategy at different structural breaks and structural regimes. The most common types of regime changes are from economic expansion to recessions and from…
Problems in Backtesting
I. Survivorship Bias Survivorship bias occurs when a conclusion is drawn from data whose scope only captures companies that survived until the date the backtesting was done. It is worth clarifying that many practitioners fail to quantify the effects of…
Metrics and Visuals Interpretation
Most quantitative stock selection models use a multifactor structure. For example, fundamental managers use multiple filters to screen stocks. The two multifactor equity portfolio strategies most commonly used to illustrate backtesting are benchmark (BM) factor portfolio and risk parity (RP)…
Backtesting an Investment Strategy
Backtesting is an investment strategy evaluation technique. It uses past data to test real-life investment processes to assess whether a strategy would yield desirable outcomes. Objectives of Backtesting Backtesting offers investment strategy-related rigor and insight to investors. Backtesting is used…
The Backtesting Process
There are three steps in backtesting: strategy design, historical investment simulation, and analysis of backtesting. Step 1: Strategy Design The first step is to formulate the investment hypothesis and goals. An active strategy would aim to achieve excess returns above…
Approaches in Valuing Real Estate
Valuation of Real Estate Properties Valuation of any commercial property is intrinsically valuable as it determines the worth of any particular real estate property. Income Valuation Approach In this scenario, a comparison is created where an investors’ acquisition price…
Valuation Discounts and Premiums
Public company valuations are based on liquid share exchange, while private company valuations adjust for control and limited share exchange. The highest value comes from a strategic buyer with synergy potential and a willingness to assume execution risk. Financial buyers…
Asset-Based Approach (Cost Approach)
The principle underlying the asset-based approach is that the value of ownership of an enterprise is equivalent to the fair value of its assets less the fair value of its liabilities. The asset-based approach, also known as the cost…
