Week 3

Is COVID-19 a Market Tail

Event?

- Quantifying Rewards and

Uncertainty

UTS CRICOS 00099F

Recap
Week 1 Week 2
Week 2 - Predictive Analysis
Week 1 - Descriptive Analysis
▪ Found up to 30% mark differences ▪ Forecast the cost of a Harvard MBA
between Studied vs Did Not Study within a forecast error of ~USD 1,300
RETURNS

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Returns

Frequency
▪ Frequency:
▪ Daily, Monthly, Yearly

Time Period
▪ Time Period:
▪ 1 month, 1 year, 10 years
Returns

▪ Arithmetic Mean: Average return

▪ Geometric Mean: Average compounded growth of an investment

Returns

▪ Arithmetic Mean: Average return

▪ Geometric Mean: Average compounded growth of an investment

Arithmetic vs Geometric: Example

Starting Closing
Year Balance Return Balance
1 100.0 20% 120.0
2 100.0 10% 110.0
3 100.0 -50% 50.0
4 100.0 30% 130.0
Profit 10.0

Mean Return = 2.5%

Arithmetic vs Geometric: Example

Starting Closing
Year Balance Return Balance
1 100.0 20% 120.0
2 120.0 10% 132.0
3 132.0 -50% 66.0
4 66.0 30% 85.8
Arithmetic vs Geometric: Example

Starting Closing
Year Balance Return Balance
1 100.0 20% 120.0
2 120.0 10% 132.0
3 132.0 -50% 66.0
4 66.0 30% 85.8

Geometric Mean

Geometric Mean = -3.8%

Arithmetic vs Geometric: Example

Starting Closing
Year Balance Return Balance
1 100.0 20%
-3.8% 120.0
96.2
2 120.0
96.2 10%
-3.8% 132.0
92.6
3 132.0
92.6 -50%
-3.8% 66.0
89.1
4 66.0
89.1 30%
-3.8% 85.8

Mean Return
Geometric Mean= =2.5%
-3.8%
RISK

UTS CRICOS 00099F

Risk

Uncertainty that can be quantified ”Never cross a river that’s 4-feet deep on average”
Nassim Taleb

▪ Standard Deviation

▪ Downside Risk

▪ Value at Risk (Week 4)

▪ Beta (Week 9)
https://towardsdatascience.com/never-cross-a-river-4-feet-deep-on-
average-d1a8d1ec345c
Standard Deviation (Volatility)
Standard Deviation (Volatility) - Example
Downside Deviation (Risk)

▪ Risk that returns fall below a

predetermined target return
▪ Measures ”bad” volatility only
Downside Risk - Example
PERFORMANCE
METRICS

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Performance Metrics

Risk-adjusted returns:

Sharpe Ratio Sortino Ratio

DECISION-MAKING
BIASES

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Prospect Theory

▪ Developed by Daniel Kahneman and

Amos Tversky in 1979
▪ Describes how people make decisions
based on perceived losses and gains
Prospect Theory – Example 1

Option Scenario 1 Scenario 2

90% 10%
1 1,000 0
2 900 900
Prospect Theory – Example 2

Option Scenario 1 Scenario 2

90% 10%
1 -900 -900
2 -1000 0
Loss Aversion

• The pain of losing is psychologically

more powerful than the pleasure of
gaining
• People weigh potential costs and
failures more heavily than potential
benefits and rewards
Loss Aversion
IN-CLASS ACTIVITY

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In-class Activity

Problem: Is COVID-19 a Market Tail Event?

Criteria: Probability of Post-COVID market returns

Alternatives: Pre vs Post-COVID data

Data: Daily returns for the Australian share market (2014-2020)

Yahoo Finance
Australian Share Market

▪ Market Index: S&P/ASX 200

▪ Sector Indices:

▪ Consumer Discretionary ▪ Information Technology

▪ Consumer Staples ▪ Materials
▪ Energy ▪ Real Estate
▪ Financials ▪ Telecommunication Services
▪ Health Care ▪ Utilities
▪ Industrials
https://www.marketindex.com.au/asx-sectors