Finformatics: How to Measure Really Small Things

The orthodoxy has a tendency to ignore drift which leaves opportunity for finformaticians the market over Kent Osband writes

Traders in financial assets implicitly compare the trading price to the stream of dividends the assets stand to generate. Clearly, a key determinant of value—usually the key determinant— will be the long-term drift or rate of growth or rather, it’s clear to everyone except orthodox finance theorists.You see, orthodox finance has been mesmerized by Black-Scholes— where the drift, exactly offset by risk-aversion, drops out of equilibrium option values—into believing that the drift never matters. But this assumes that everyone knows what the drift is. In reality, that hardly ever  applies. It can’t, both because the drift is too shrouded in noise to measure exactly and because the drift tends to change over time. In consequence, people with superior knowledge of the drift stand to profit from betting against the market consensus.

Logged-in members can download the article by clicking the link below. To log in or register visit here.

120312_osband