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Markov Financial Model

Markov Financial Model

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Published by Becky Glymph

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Published by: Becky Glymph on Feb 10, 2012
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Rather than the predefined 20-day training window, the size of the training pool and

training window could be decided by a hill climbing or dynamic programming approach.

Identifying useful side information for prediction, such as developing of new indicators will

help making better predictions. Then we can extend the prediction to a form of density

function rather than simply values. This way can we output richer information about the

market movements.

Functions and how functions are mixed at each state are not studied in this thesis. This

can be a valuable work to do. Gaussian distribution is the most popular distribution when

modeling random or unknown processes. But it has been observed that many time series

may not follow the Gaussian distribution.

In this thesis, we discussed the application of the Hidden Markov Model to one single

financial time series, more specifically, we studied the S&P 500 Composite Index. We didn’t

take the portfolio selection problem into consideration. Since different financial time series

have different characteristics, a portfolio composed of different stocks will have different

rate of returns and risk levels. In other words, they will have different patterns. It will be

interesting to apply the HMM technique to a portfolio of financial assets and study the time

series generated by these groups of assets. The Viterbi algorithm could play an important



role in this application. If we put functions that are estimated to best characterize different

assets at different states, the path of the Viterbi algorithm will be able to tell what assets

should be included in the portfolio, observing the price movements. [Cov91] offers a nice

introduction to universal portfolio selection problem.

The double weights in the HMGM model can also be trained. These weights decide the

sensitivity of the model, so by setting up a function that studies the relationship between

sensitivity and accuracy, we can expect to find better weights.

The outputs of the HMGM models we present in the thesis are positive and negative

symbols. A more delicate model will be able to output densities rather than symbols, i.e.,

by how much probability the market will go up or down. Furthermore, the density can be

designed to describe the probability of falling into a range of values.

Appendix A

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