Alternative expectations model and its application in portfolio analysis

Abstract

Purpose: Statistical reliability improvement and development of the apparatus of the mathematical market simulation used in the process of investment decisions verification. Discussion: The authors suggest clarification of nature and mechanism of the market profitability generation under the conditions of the alternative expectations hypothesis. The emphasis is put on the development of technique of group specific risk decomposition on systematic component, occurred under the influence of non-systematic external factor, and residual random variable. The techniques of non-systematic external factor simulation using instrumental variables are considered. Results: The authors have suggested the system of equations describing dynamics of security profitability. This system allows to take into account both systematic linear factors (market dynamics, dynamics of assets groups) and non-systematic nonlinear. There are provided schematic derivation of necessary formulas and their conceptual interpretation. The technique of effective portfolio creation using diagonal model under the conditions of nonsufficient statistical reliability of parameters is considered in the empirical part of the study.