[I plan to make this page more visual.. please check back for updates]
Absolute Convergence The idea that developing countries, regardless of their particular characteristics, will eventually catch up with the developed countries and match them in per captia output.
Absolute Version of PPP
Activist short selling the fund manager not only takes a short position in a stock, but also presents research that contends that the stock is overpriced
Adjusted R-Squared A measure of goodness-of-fit of regression that is adjusted for degrees of freedom and hence does not automatically increase when another independent variable is added to a regression.
Active investors are individuals who have been actively involved in wealth creation through investment, and they have risked their own capital in achieving their wealth objectives. Active investors have a higher tolerance for risk than they have need for security.
Active Risk The standard deviation of the differences between a portfolio’s returns and its benchmark’s returns; a synonym of tracking error. Also called tracking risk.
Adverse Selection Pre-contractual opportunism where one party to a contract (e.g. purchaser of a insurance) uses his private information to the other counterparty's disadvantage.
Alpha Decay In a trading context, alpha decay is the erosion or deterioration in short term alpha after the investment decision has been made.
Anchoring and adjustment An information-processing bias in which the use of a psychological heuristic influences the way people estimate probabilities.
ANOVA The analysis of the total variability of a datatset (such as observations on the dependent variable in a regression) into components representing different sources of variation, with reference to regression., ANOVA provides the inputs for an F-test of the significance of the regression as a whole
Anti-Trust Law: Laws that ban the collusion (or other anti-competitive behavior) between firms in the same market. The law is designed to protect consumers.
Algorithmic Trading The use of computer algorithms to place and manage orders in the market. Some algorithms operate on behalf of a human trader; others are completely autonomous.
ARPU (Average Revenue Per Unit) A commonly used KPI in the telecom industry for revenue generated from the sale of one cell phone.
Auctions A trading method that is used to sell everything from electricity to eBay collectibles
Autocorrelation - The correlation of a time series with its own past values; values must lie between -1 and +1
Automatic stabilizers are mechanisms built into government budgets, without any vote from legislators, that increase spending or decrease taxes when the economy slows. Automatic stabilizers play an important role in mitigating cyclical fluctuations
Autoregressive Model A time series regressed on its own past values in which the independent variable is lagged value of a dependent variable
Availability bias is the tendency to be overly influenced by events that have left a strong impression and/or for which it is easy to recall an example
Balance of payments A summary of all economic transactions between a country and all other countries for a specific time period, usually a year.
Barbell strategy is formed when a Trader invests in Long and Short duration bonds, but does not invest in the intermediate duration bonds. This strategy is useful when interest rates are rising; as the short term maturities are rolled over they receive a higher interest rate, raising the value.
Base rate neglect is the tedency for people to mistakenly judge the likelihood of a suitation by not taking into account all relevant data
Basket trading Trading not with single instruments but with multiple instruments (a basket), with the value of the basket being continuously recalculated in real time.
Bayes' Formula A mathematical rule explaining how existing probability beliefs should be changed given new information; it is essentially an application of conditional probabilities.
Behavioral finance A new field that combines economics and psychology
Behavioral finance macro considers market anomalies that distinguish markets from the efficient markets of traditional finance.
Behavioral finance micro examines behaviors or biases that distinguish individual investors from the rational actors envisioned in neoclassical economic theory.
Benchmark A reference point for evaluating portfolio performance
Bid A solicitation to buy
Black box An algorithm for which the workings are hidden.
BLUE (best linear unbiased estimator) is one that provides the lowest sampling variance and which is also unbiased
Bounded Rationality The notion that people have informational and cognitive limitations when making decisions and do not necessarily optimize when arriving at their decisions.
Breush-Pagan Test A test for conditional heteroskedasticity in the error term of a regression
Business cycle Fluctuations in the growth of real output, or real GDP, consisting of alternating periods of expansion (increasing real output) and contraction (decreasing real output); also known as trade cycles
Business cycle phases
Butterfly spread An option strategy that combines two bull or bear spreads and has three exercise prices
Calendar effects the systematic tendency for a series, especially stock retruns, to be higher at certain times than others.
Capital Deepening An increase in the capital-to-labor ratio
Capital Market Expectations Expectations concerning the risk and return prospects of asset classes.
Carhart model a time series model for explaninng the performance of mutual funds or trading rules based on four factors: excess market returns, size, value and momentum
Carried Interest a share in the profits of a private equity fund. Typically, a fund must return the capital given to it by limited partners plus any preferential rate of return before the general partner can share in the profits of the fund. The general partner will then receive a 20% carried interest, although some successful firms receive 25%-30%. Also known as “carry” or “promote”.
Causal inference Inference that focuses on establishing that a change in one variable causes a change in another variable.
Causation vs. Correlation: Causation is when one thing causes another. Correlation is when as one thing increases, another thing also increases. Correlation does not imply causation.
Central bank An institution that regulates the banking system and controls the supply of money of a country
Chatham House rule participants are free to use the information received, but neither the identity nor the affiliation of the speaker(s), nor that of any other participant, may be revealed
Child order - An order generated by a trading algorithm and put in the market to execute part of the overall parent order.
Closet indexer A fund that advertises itself as being actively managed but is substantially similar to an index fund in its exposures.
Club Convergence - The idea that only rich and middle-income countries sharing a set of favorable attributes (i.e., are members of the “club”) will converge to the income level of the richest countries.
Clustering Data analytics that focuses on sorting observations into groups (clusters) such that observations in a cluster are more similar to each other than they are to observations in other clusters
Coase Theorem states that if an externality can be traded and there are no transaction costs, then the allocation of property rights will be efficient and the resource allocation will not depend on the initial assignment of property rights.
Cobb-Douglas production function
Cointegrated - Describes two times series that have a long-term financial or economic relationship such that they don't diverge from each other without bound in the long run.
Collar A portfolio consisting of a long position in a put and a short position in a call, collaring the underlying security selling price to lie between the exercise prices of the two option contracts
Co-location (co-lo) - The act of locating trading algorithms next to a trading venue or in a site with very low latency connections to a trading venue in order to reduce overall end-to-end trade latency.
Commitment an obligation, typically the maximum amount that a limited partner agrees to invest in a fund.
Competitive markets The idea that two individual (or two countries) can both gain from trade even if one of them is better than the other at everything
Complex event processing (CEP) - A platform specifically designed for complex analysis and response to high-frequency data. CEP platforms typically include modeling tools, a CEP engine, and market data connectors.
Consumer choice theory is the branch of microeconomics that relates consumer demand
curves to consumer preferences
Consumer Confidence A measure of the degree of optimism of consumers about their future income and the future of economy; it is measured on the basis of surveys consumers. Is an important determinant of the consumption of aggregate demand.
Corner The purchase of a sufficient level of a given security to obtain market or monopoly power over its price
Convexity (1) The slope of the slope of a function (2) The sensitivity of the duration of a bond to changes in the market rate of interest.
Conditional Convergence
Cross-validation A set of model validation techniques that have the objective of controlling for bias in training data
The Current Account of the balance of payments comprises the balance of trade in goods and services plus net investment incomes from overseas assets and net transfers.
Cyclically balanced budget Occurs when the government runs a deficit during recessions and lean years but a surplus during periods of significant growth.
Cyclical Themes: occur at somewhat regular short or medium term intervals, typically based on changes in the business cycle. These cyclical trends can be mean-reverting, so that over a long period of time they tend to converge with some average level. Examples can include asset valuations, volatility, interest rates, and currency values.
Dark pools Trading venues that do not publish their liquidity and are only available to selected clients.
Data mining is the practice of finding forecasting models by searching through databases for correlations, patterns or trading rules.
Deadweight Loss: Surplus that is lost when a mutually beneficial trade no longer occurs, but would have under perfect competition.
Default risk The probability that a borrower defaults or fails to meet its obligation to make full and timely payments of principal and interest, according to the terms of the debt security.
Deflation A continuing (or sustained) decrease in the general price level
Depth A market's ability to process and execute a large order without substantantially impacting its price.
Diffusion index An index that measures how many indicators are pointing up and how many are pointing down
Direct market access (DMA) - A way for buy-side firms (such as hedge funds) to trade using the exchange membership of a sell-side firm. The buy-side firm sends the trades directly to market over a DMA connection to the sell-side firm. In this way, a buy-side firm can run its own proprietary algorithms without having to rely on or share knowledge with the sell-side firm. (See also “sponsored access.”)
Disinflation Refers to fall in the rate of inflation; it involves a positive rate of inflation and should be contrasted with deflation
Disposition effect As a result of loss aversion, an emotional bias whereby investors are reluctant to dispose of losers. This results in an inefficient and gradual adjustment to deterioration in fundamental value i.e. "Sell winners, hold losers"
The Dow Dividend approach (aka Dogs of Dow) The Dow Dividend approach sorts DJIA stock by
their dividend yields at the beginning of each year and then buys an equally-weighted portfolio of the
ten highest-yielding stocks. This strategy was popularized by Michael o'Higgins book with John
Downs, Beating the Dow, first published in 1991.
Dominant strategy A strategy (such as confessing in the Prisoners Dilemma) that generates the best
outcome for a player regardless of the other players' strategies.
Double inflection utility function - A utility function that changes based on levels of wealth.
Dummy variable - A type of qualitative variable that takes on a value of 1 if a particular condition is true and 0 if that condition is false.
Dutch Disease - A situation in which currency appreciation driven by strong export demand for resources makes other segments of the economy (particularly manufacturing) globally uncompetitive.
Econometrics - Branch of economics, designed for immediate statistical estimation and empirical application.
Extended portfolio assets and liabilities Assets and liabilities beyond those shown on a conventional balance sheet that are relevant in making asset allocation decisions; an example of an extended asset is human capital.
Factor Beta An asset’s sensitivity to a particular factor; a measure of the response of return to each unit of increase in a factor, holding all other factors constant.
Factor Models can be used in top down analysis to forecast returns based on sensitivities and risk factors. A random error has zero mean and uncorrelated with the factors.
Fallacy of composition Erroneous view that what is true for the individual (or the part) will also be true for the group (or the whole)
Fed funds rate The US interbank lending rate on overnight borrowings of reserves.
Federal Reserve System The central bank of the united States; it carries out banking regulatory policies and is responsible for the conduct of monetary policy
Free cash flow The actual cash that would be available to the company’s investors after making all investments necessary to maintain the company as an ongoing enterprise (also referred to as free cash flow to the firm); the internally generated funds that can be distributed to the company’s investors (e.g., shareholders and bondholders) without impairing the value of the company.
Free Rider Problem: When people can benefit from goods they don't produce or pay for.
Free Trade: International trade without any restrictions, tariffs, or quotas.
Filtration History or indexed set of sub objects in a stochastic process
Fisher effect The thesis that the real rate of interest in an economy is stable over time so that changes in nominal interest rates are the result of changes in expected inflation.
Gamma Sensitivity of an option's delta to changes in the price of the underlying security
Game Theory The study of strategy, decisions and outcomes in competitive situations.
Giffen goods Goods that are consumed more as the price of the good rises because it is a very inferior good whose income effect overwhelms its substitution effect when price changes.
Grinold–Kroner model An expression for the expected return on a share as the sum of an expected income return, an expected nominal earnings growth return, and an expected repricing return.
Hawks & Doves - Hawks worry about inflation. They believe there are costs associated with it. SO when hawks spy inflation, they argue for preemptive thinking. To ensure that inflation remains low and stable, they are willing to take the risk that the unemployment rate may not always be at its lowest sustainable level.
Doves, on the other hand, worry more about unemployment. They want to see monetary policy positioned to ensure that the economy achieves the highest sustainable level of employment. They might for example, be willing to tolerate inflation above the level associated with price stability for a while to avoid disrupting an economy already at full employment. And they might be more willing to risk some upturn in inflation to make sure that they had driven the unemployment rate to its lowest sustainable level.
Herding When a group of investors trade on the same side of the market in the same securities, or when investors ignore their own private information and act as other investors do.
Heteroskedacticity The property of having a non constant variance; refers to an error term with the property that its variance differs across observations.
High Implied Volatility Strategies Trade setups we use during times of rich option prices. We like to collect credit/sell premium, and hope for a contraction in volatilityHome-Country Bias
The favoring of domestic over non-domestic investments relative to global market value weights.
Homoskedacticity - The property of having a constant variance; refers to an error term that is constant across observations.
House Money Effect Refers to the tendency of individual investors to take on greater risks when investing with profits attained. This effect gets its name from the casino saying, ‘playing with the house's money’. This effect was first described by Richard Thaler and Eric J. Johnson of Cornell University.
High-frequency trading (HFT) algorithms High-frequency trading uses autonomous algorithms that analyze and respond to real-time market data to decide what, how, and when to trade. Typically, they are fast-moving algorithms that analyze thousands of market events per second and make sub-millisecond trading decisions. Often, the holding time for stocks is very short—potentially intra-day holding or even holding for only a few seconds! Examples of HTF Algo - Pairs Trading, Index Arbitrage, Basket Trading, Spread Trading, Mean Reversion and Delta Neutral Strategies
Human capital mortality-weighted net present value (NPV) of future expected labor income
Implementation shortfall algorithm An algorithm that minimizes the trade-off between the market impact of immediately executing an order versus the risk of market drift if the order takes too long to execute.
Implied Volatility is not observable per se, but it is derived from an option pricing model—such as the Black–Scholes–Merton (BSM) model—and it is value that equates the model price of an option to its market price
Immunization is the process of constructing a portfolio that has, to first order, no interest rate risk
Index arbitrage Monitoring for breaks in the correlated relationships between instruments and the index of its sector (e.g., Ford against the automotive sector or a stock index future against one or more of its underlying component elements).
Insider trading A form of market abuse in which traders gain information that they should not be party to and trade using that information (e.g., good or bad news on a company).
Latency The time difference between stimulus and response. In a trading algorithm context, it is the amount of time from the market data being received, a pattern being identified, a decision being made, and trades being placed. In algorithmic trading, the lowest end-to-end latency possible is desirable.
Inflation indexes - Consumer price indexes reflect the prices of a basket of goods and services that is typically purchased by a normal household. Producer price indexes measure the cost of a basket of raw materials, intermediate inputs, and finished products. GDP deflators measure the price of the basket of goods and services produced within an economy in a given year. Core indexes exclude volatile items, such as agricultural products and energy, whose prices tend to vary more than other goods
International Fisher Effect - The proposition that nominal interest rate differentials across currencies are determined by expected inflation differentials.
Inter-temporal rate of substitution The ratio of the marginal utility of consumption s periods in the future (the numerator) to the marginal utility of consumption today (the denominator).
Inventory cycle is thought to be 2 to 4 years in length. It is often measured using the inventory to sales ratio. The measure increases when businesses gain confidence in the future of the economy and add to their inventories in anticipation of increasing demand for their output
Invisible hand Adam Smith's metaphor for how individual self-interest can lead to good outcomes for the group as a whole
Jensen's alpha Excess return on a portfolio over the CAPM-implied risk-adjusted return
Joint Probability if A, B, C,.. are statistically independent events, meaning that the probability of their occurring together is equal to the product of their individual probabilities. P(ABC..) is referred to as joint probability
Kinked demand curve A model developed to explain price inflexibility of oligopolistic firms that don't collude (do not agree to collaborate in order to limit competition between them)
Kurtosis A measure of how tall or flat the normal distribution is (2) the standardised fourth moment of a series; a measure of whether a series has ‘fat tails’.
Lasso (Least Absolute Shrinkage and Selection Operator) regression is a type of linear regression that uses shrinkage. Shrinkage is where data values are shrunk towards a central point, like the mean. The lasso procedure encourages simple, sparse models (i.e. models with fewer parameters). This particular type of regression is well-suited for models showing high levels of muticollinearity or when you want to automate certain parts of model selection, like variable selection/parameter elimination.
Law of large numbers A mathematical theorem that says repeating a bet large number of time is likely to produce an average outcome close to the expected value
Layering Using fictitious orders on one side of the market to manipulate algorithms to buy a real order on the other side of the market.
Leading Economic Indicators - A set of economic variables whose values vary with the business cycle but at a fairly consistent time interval before a turn in the business cycle.
Liability Driven Investing An investment industry term that generally encompasses asset allocation that is focused on funding an investor’s liabilities in institutional contexts.
Liquidity aggregation Monitoring multiple trading venues in a fragmented market and combining their order books into a “super book” so a trader or algorithm can always find the best price and liquidity combination.
Lognormal A variable's probability distribution is lognormal if the logarithm of the variable has a normal distribution
M1 (money supply) The sum of (1) currency in circulation (including coins) (2) checkable deposits held in depository institutions and (3) money market mutual fund shares
Machine learning Diverse approaches by which computers are programmed to improve performance in specified tasks with experience
Market fragmentation The development of multiple markets in a given asset class that each list the same instruments. For example, there are many US equities venues listing the same stocks.
Market architecture The set of rule governing the trading process
Market impact The effect that a given transaction has on the market price of a security
Market microstructure Area of financial economics concerned with trading and market structure, market fairness, success and failure, and how the design of the market affects price formation and discovery.
Molodovsky Effect - The observation that P/Es tend to be high on depressed EPS at the bottom of a business cycle, and tend to be low on unusually high EPS at the top of a business cycle.
The P/E tends to rise during periods of economic expansion and to fall during recessions. A “high” P/E could be the result of a number of factors, including the following: falling real interest rates, a fall in the equity risk premium, an increase in the expectation of future real earnings growth, an expectation of lower operating and/or financial risk, or a combination of all of these factors. All of these components will be influenced by the business cycle.
Momentum crashes periods where 'losers' tend to outperform 'winners'
Mundell-Fleming Trilemma
NAIRU (Non-Accelerating Inflation Rate of Unemployment) It is the minimum sustainable unemployment rate - the lowest unemployment rate that can be sustained without lifting inflation. The NAIRU is central to FOMC's decisions, since it sets the limits to where the unemployment rate should be pushed.
Naked access Where algorithmic trade orders do not pass through pre-trade risk controls, potentially leading to runaway executions
Nash Equilibrium: In game theory, a Nash Equilibrium occurs when each player has chosen a strategy that it will not want to change, given what the other players have chosen.
Natural Monopoly: A type of monopoly that occurs when fixed costs are incredibly high, which means average total cost is always dropping as output increases.
Negative Externality: In a mutually beneficial trade between two people (A and B), a negative externality occurs when a third party (person C) is negatively affected by the trade, but neither person A or B bear this cost.
Negative Rate is defined as the net payment made to keep money on deposit at a financial institution or payment of a net fee to invest in short-term instruments
Non-Excludable: When a firm can't prevent people from consuming the good without paying for it.
Non-Rival: When more than one person can consume the same unit of the good at same time.
Normal Goods: Goods you consume less of when your income goes down (alternatively, goods you consume more of when your income goes up).Nationally Recoginzed Statistical Rating Organization (NSSRO) A credit rating agency whose ratings the US SEC has designated as authoritative for certain regulatory purposes
Net asset value (NAV) Market value of a portfolio assets minus liabilities at a particular point in time divided by the number of shares in the portfolio outstanding at that time
Non-Deliverable Forwards Forward contracts that are cash settled (in the non-controlled currency of the currency pair) rather than physically settled (the controlled currency is neither delivered nor received).
No-load fund Mutual fund that accepts investments directly from investors without a sales charge
Offer A solicitation to sell (also called an ask)
Opaque markets Markets that lack transparency
Order driven markets Markets where traders can trade without the inter mediation of dealers
Order Protection Rule Provision from the 2007 NMS legislation that provides intermarket price priority for quotations that are immediately accessible
Out trades Trade reports filed with futures clearing firms or clearing houses with discrepancies resulting from recording errors, misunderstanding and fraud
Overconfidence bias People demonstrate unwarranted faith in their own intutive reasoning, judgements and/or cognitive abilities. Overcoming the bias - "Dont confuse brains with a bull market"
Paid-in Capital the amount of committed capital a limited partner has actually transferred to a
fund. Also known as the cumulative takedown amount.
Painting the tape A manipulative practice in which a trader continuously takes the best offer in the market in a particular instrument to drive the price up; then the trader sells a large quantity of the same instrument.
Partial Regression Coefficients - The slope coefficients in a multiple regression. Also called partial slope coefficients.
Pecking order hypothesis the notion from corporate finance that firms will select the cheapest method of financing (usually retained earnings) first before switching to increasingly more expensive forms
Personal consumption Household spending on consumer goods and services during the current period. Consumption is a flow concept
Portfolio Company a company that has received an investment from a private equity fund.
Positive Economics The scientific study of "what is" among economic relationships
Power of a test the ability of a test to correctly reject a wrong null hypothesis
Price ceiling A legally established maximum price that sellers may charge for a good or a resource
Price controls Government-mandated prices; they may be either greater or less than the market equilibrium price
Price deflator a series that measures the general level of prices in an economy, used to adjust a nominal series to a real one
Price discovery The process of determining the worth or price of an asset in the marketplace through the interactions of buyers and sellers
Price discrimination A practice whereby a seller charges different consumers different prices for the same product or service
Private Equity are firms that make range of investments ranging from investments in early stage companies (called a venture capital investment) to investments in mature companies (generally in a buyout transaction)
Probability distribution The mathematical description of how probable it is that the value of something is less than or equal to a particular level
Prompt month The front month - i.e the nearest expiring futures contract in commodities
Prospect Theory An alternative to expected utility theory, it assigns value to gains and losses (changes in wealth) rather than to final wealth, and probabilities are replaced by decision weights. In prospect theory, the shape of a decision maker’s value function is assumed to differ between the domain of gains and the domain of losses.
PPP - The idea that exchange rates move to equalize the purchasing power of different currencies.
Pseudo-random numbers a set of artifical random-looking numbers generated using a purely deterministic sequence
Psychographics is a qualitative methodology used to describe consumers on psychological attributes. Psychographics have been applied to the study of personality, values, opinions, attitudes, interests, and lifestyles
Quadruple witching refers to the third Friday of every March, June, September and December. On these days, market index futures, market index options, stock options and stock futures expire, usually resulting in increased volatility.
Qualified institutional buyer (QIB) Institution with an investment portfolio exceeding $100 million
Quantitative easing attempts to spur aggregate demand by drastically increasing the money supply.
Quote-driven markets Markets where dealers post quotes and participate on at least one side of every trade
Quote rule Formally referred to as SEC Rule 602 of Regulation NMS, requires that all market centers publicly disseminate their best bids and offers thought the securities information processors
Quote stuffing The placement of large numbers of rapid-fire stock orders, with most or all of which being canceled almost immediately, frequently for the purpose of clogging trading HFT and other algorithms and data computations
Random walk theory The theory that current stock prices already reflect known information about the future. Therefore, the future movement of stock prices will be determined by surprise occurrences. This will cause them to change in a random fashion
Real Interest Rate Parity - The proposition that real interest rates will converge to the same level across different markets.
Real Values Values that have been adjusted for the effects of inflation
Repo Rate The interest rate on a repurchase agreement.
Ricardian equivalence The view that a tax reduction financed with government debt will excert no impact on current consumption and aggregate demand because people will fully recognize the higher future taxes implied by the additional debt
Rule of 70 If a variable grows at a rate of x percent per year, 70/x will approximate the number of years required for the variable to double
Second movement the movements of a distribution define its shape; the second moment is another term for the variance of the data
Secondary effects Consequences of an economic change that are not immediately identifiable but are felt only with the passage of time
Sharpe ratio this is a risk-adjusted
Short squeeze is a situation in which a stock's price increase triggers a rush of buying activity among short sellers. Short sellers must buy stock to close out their short positions and cut their losses, which results in a further increase in stock prices, which compel still more short sellers to cover their positions.
Shrinkage estimator is a new estimate produced by shrinking a raw estimate (like the sample mean)
SKEW index - The SKEW index is a measure of potential risk in financial markets. Much like the VIX index, the SKEW index can be a proxy for investor sentiment and volatility.
Small firm effect - Evidence suggesting that small-cap stocks outperform large-cap stocks over time.
Social proof A bias in which individuals tend to follow the beliefs of a group (i.e. group think).
Soft Landing a soft landing occurs when growth slows - just as the economy reaches full employment - so the unemployment rate remains steady. If inflation is also low enough, at this point, the FOMC has achieved its two primary objectives - full employment and price stability
Spoofing Using fictitious limit orders to manipulate prices.
Spread duration A measure used in determining a portfolio’s sensitivity to changes in credit spreads.
Straddle A combination of put and call options with identical exercise prices on the same underlying asset.
Structural Themes: occur as one-off shifts that change an existing paradigm. These structural changes tend to be longer term in nature and are typically driven by powerful forces such as disruptive technologies or changing demographics and consumer behavior.
Systemic risk - the risk of failure of the financial system
Steady state of growth - The constant growth rate of output (or output per capita) which can or will be sustained indefinitely once it is reached. Key ratios, such as the capital–output ratio, are constant on the steady-state growth path.
Stochastic process A sequence of random variables xt indexed by time t. In other words, a stochastic process is a random series of values xt sequenced over time
Supply shock An unexpected event that temporarily either increases or decreases aggregate supply
Supervised learning A machine learning approach that makes use of labeled training data
Survivorship bias - Bias that may result when failed or defunct companies are excluded from membership in a group.
𝛑∗t is the target rate of inflation, and Yt and Y∗t are, respectively, the logarithmic levels of actual and potential real GDP. The difference between Yt and Y∗t is known as the “output gap,” which is essentially measured in percentage terms.
Tax incidence Refers to the burden of tax, or those who are the ultimate payers of the tax
TED spread is an indicator of perceived credit risk in the general economy. TED is an acronym formed from US T-bill and ED, the ticker symbol for the eurodollar futures contract. The TED spread is calculated as the difference between Libor and the yield on a T-bill of matching maturity. An increase (decrease) in the TED spread is a sign that lenders believe the risk of default on interbank loans is increasing (decreasing). Therefore, as it relates to the swap market, the TED spread can also be thought of as a measure of counterparty risk. Compared with the 10-year swap spread, the TED spread more accurately reflects risk in the banking system, whereas the 10-year swap spread is more often a reflection of differing supply and demand conditions.
Theta Sensitivity of an option's price to changes in the option's time to expiry
Total Productivity Factor (TPF) - A multiplicative scale factor that reflects the general level of productivity or technology in the economy. Changes in total factor productivity generate proportional changes in output for any input combination. Y = A F(K,L) in this function A is the TPF.
Trade through The execution of an NMS stock trade at a price inferior to a protected quotation for that stock
Transition probabilities a square matrix of estimates of the likelihood that a markov switching variable will move from a given regime to each other regime
Treynor Ratio Index of risk-adjusted portfolio performance, calculated as the portfolio's excess return on the riskless rate relative to its beta
Unanticipated inflation An increase in general level of prices that was not expected by most decision makers
Unit root tests are tests for stationarity in a time series. A time series has stationarity if a shift in time doesn’t cause a change in the shape of the distribution; unit roots are one cause for non-stationarity.
Upstairs markets Markets where institutions trade securities directly among themselves. Also called fourth markets.
Unsupervised learning A machine learning approach that does not make use of labeled training data
Utility The subjective benefit or satisfaction a person expects from a choice or course of action
Utility Theory Theory whereby people maximize the present value of utility subject to a present value budget constraint.
Value Trap occurs when a value investor buys stock that looks undervalued but the business continues to deteriorate.
VaR an approach to measuring risk based on the loss on a portfolio that may be expected to occur with a given probability over a specific horizon
Veblen goods Goods that increase in desirability with increasing price.
Vega Sensitivity of an option's price to changes in the underlying security's standard deviation of returns.
Venture Capital An alternative management vehicle that invests capital in a private portfolio companies in development stages that have a strong potential for rapid growth
Vintage: the year that a private equity fund stops accepting new investors and begins to make
investments on behalf of those investors
VIX (the Fear Index) An implied of implied volatility of 30-day options on the S&P 500. A VIX reading of 20 indicates an expected annualized move of 20 percent in S&P 500 over the next 30 days. VIX hit an all-time high of ~90 in October 2008, after the Lehman Brothers collapse. VIX tends to trade between 10 and 20 during periods of complacence and shoots up amid market winners
Volatility the extent to which a series is highly variable over time, usually measured by its standard deviation or variance
Volatility Clustering The tendency for large (small) swings in prices to be followed by large (small) swings of random direction.
Volatility Skew refers to the difference in implied volatility of each opposite, equidistant option. The current volatility skew in the market results in puts trading richer than calls, because the IV in OTM puts is higher than the equivalent OTM calls. Velocity also attributes to the skew, since markets can fall much faster than they rise. Before the crash of 1987, this skew did not exist.
Volatility Smile The U-shaped plot (of implied volatility (y-axis) against strike price (x-axis) for options on the same underlying with the same expiration) that occurs when the implied volatilities priced into both OTM puts and calls trade at a premium to implied volatilities of ATM options.
Weakly stationary process has a fixed mean and varaiance but no other structure (e.g. it has zero autocorrelations for all lags). The error term in a regression model is usually assumed to be white noise
Winner's Curse Problem occurring when the winning bidder bids the most, and is the most likely to have bid too much for the auctioned object
Yield curves show how the yields on bonds vary as the term to maturity increases.
Yield to maturity The internal rate of return of a bond
Zero cost collar A collar where the time zero proceeds from the call sale exactly offsets the cost of the put purchase. The options' exercise prices are set so that the call and the put have the same values
Zone of Insolvency
Absolute Convergence The idea that developing countries, regardless of their particular characteristics, will eventually catch up with the developed countries and match them in per captia output.
Absolute Version of PPP
Activist short selling the fund manager not only takes a short position in a stock, but also presents research that contends that the stock is overpriced
Adjusted R-Squared A measure of goodness-of-fit of regression that is adjusted for degrees of freedom and hence does not automatically increase when another independent variable is added to a regression.
Active investors are individuals who have been actively involved in wealth creation through investment, and they have risked their own capital in achieving their wealth objectives. Active investors have a higher tolerance for risk than they have need for security.
Active Risk The standard deviation of the differences between a portfolio’s returns and its benchmark’s returns; a synonym of tracking error. Also called tracking risk.
Adverse Selection Pre-contractual opportunism where one party to a contract (e.g. purchaser of a insurance) uses his private information to the other counterparty's disadvantage.
Alpha Decay In a trading context, alpha decay is the erosion or deterioration in short term alpha after the investment decision has been made.
Anchoring and adjustment An information-processing bias in which the use of a psychological heuristic influences the way people estimate probabilities.
ANOVA The analysis of the total variability of a datatset (such as observations on the dependent variable in a regression) into components representing different sources of variation, with reference to regression., ANOVA provides the inputs for an F-test of the significance of the regression as a whole
Anti-Trust Law: Laws that ban the collusion (or other anti-competitive behavior) between firms in the same market. The law is designed to protect consumers.
Algorithmic Trading The use of computer algorithms to place and manage orders in the market. Some algorithms operate on behalf of a human trader; others are completely autonomous.
AR model a time series model where the current value of a series is fitted with its previous values
ARCH (autoregressive conditional heteroscedasticity) model a time series model for volatilities
ARMA model combines both autoregressive lags of the dependent variable and moving-average errors. The equation for such a model with p autoregressive terms and q moving-average terms, denoted ARMA(p, q), is
ARCH (autoregressive conditional heteroscedasticity) model a time series model for volatilities
ARMA model combines both autoregressive lags of the dependent variable and moving-average errors. The equation for such a model with p autoregressive terms and q moving-average terms, denoted ARMA(p, q), is
xt=b0+b1xt−1+⋯+bpxt−p+εt+θ1εt−1+⋯+θqεt−qE(εt)=0,E(ε2t)=σ2,Cov(εt,εs)=E(εtεs)=0fort≠s
where b1, b2, …, bp are the autoregressive parameters and θ1, θ2, …, θq are the moving-average parameters.ARPU (Average Revenue Per Unit) A commonly used KPI in the telecom industry for revenue generated from the sale of one cell phone.
Auctions A trading method that is used to sell everything from electricity to eBay collectibles
Autocorrelation - The correlation of a time series with its own past values; values must lie between -1 and +1
Automatic stabilizers are mechanisms built into government budgets, without any vote from legislators, that increase spending or decrease taxes when the economy slows. Automatic stabilizers play an important role in mitigating cyclical fluctuations
Autoregressive Model A time series regressed on its own past values in which the independent variable is lagged value of a dependent variable
Availability bias is the tendency to be overly influenced by events that have left a strong impression and/or for which it is easy to recall an example
Balance of payments A summary of all economic transactions between a country and all other countries for a specific time period, usually a year.
Barbell strategy is formed when a Trader invests in Long and Short duration bonds, but does not invest in the intermediate duration bonds. This strategy is useful when interest rates are rising; as the short term maturities are rolled over they receive a higher interest rate, raising the value.
Base rate neglect is the tedency for people to mistakenly judge the likelihood of a suitation by not taking into account all relevant data
Basket trading Trading not with single instruments but with multiple instruments (a basket), with the value of the basket being continuously recalculated in real time.
Bayes' Formula A mathematical rule explaining how existing probability beliefs should be changed given new information; it is essentially an application of conditional probabilities.
Behavioral finance A new field that combines economics and psychology
Behavioral finance macro considers market anomalies that distinguish markets from the efficient markets of traditional finance.
Behavioral finance micro examines behaviors or biases that distinguish individual investors from the rational actors envisioned in neoclassical economic theory.
Benchmark A reference point for evaluating portfolio performance
Bid A solicitation to buy
Black box An algorithm for which the workings are hidden.
BLUE (best linear unbiased estimator) is one that provides the lowest sampling variance and which is also unbiased
Bounded Rationality The notion that people have informational and cognitive limitations when making decisions and do not necessarily optimize when arriving at their decisions.
Business cycle Fluctuations in the growth of real output, or real GDP, consisting of alternating periods of expansion (increasing real output) and contraction (decreasing real output); also known as trade cycles
Business cycle phases
- Initial recovery - Short-term interest rates and bond yields are low. Bond yields likely to bottom. Stock markets may rise strongly. Cylicial/risker assets such as small stocks, high-yield bonds, and emerging markets securities perform well
- Early expansion - Short rates are moving up. Longer-maturity bond yields are stable or rising slightly. Stocks are trending up.
- Late expansion - Interest rate rise, and the yield curve flattens. Stocks markets often rise but may be volatile. Cyclical assets may under perform
- Slowdown - Short-term interest rates are at or nearing a peak. Government bond yields peak and may then decline sharply. The yield curve may invert. Credit spreads widen, especially for weaker credits. Stocks may fall. Interest-sensitive stocks and “quality” stocks with stable earnings perform best.
- Contraction Interest rates and bond yields drop. The yield curve steepens. The stock market drops initially but usually starts to rise well before the recovery emerges. Credit spreads widen and remain elevated until clear signs of a cycle trough emerge.
Butterfly spread An option strategy that combines two bull or bear spreads and has three exercise prices
Calendar effects the systematic tendency for a series, especially stock retruns, to be higher at certain times than others.
Capital Deepening An increase in the capital-to-labor ratio
Capital Market Expectations Expectations concerning the risk and return prospects of asset classes.
Carhart model a time series model for explaninng the performance of mutual funds or trading rules based on four factors: excess market returns, size, value and momentum
Carried Interest a share in the profits of a private equity fund. Typically, a fund must return the capital given to it by limited partners plus any preferential rate of return before the general partner can share in the profits of the fund. The general partner will then receive a 20% carried interest, although some successful firms receive 25%-30%. Also known as “carry” or “promote”.
Causal inference Inference that focuses on establishing that a change in one variable causes a change in another variable.
Causation vs. Correlation: Causation is when one thing causes another. Correlation is when as one thing increases, another thing also increases. Correlation does not imply causation.
Central bank An institution that regulates the banking system and controls the supply of money of a country
Chatham House rule participants are free to use the information received, but neither the identity nor the affiliation of the speaker(s), nor that of any other participant, may be revealed
Child order - An order generated by a trading algorithm and put in the market to execute part of the overall parent order.
Closet indexer A fund that advertises itself as being actively managed but is substantially similar to an index fund in its exposures.
Club Convergence - The idea that only rich and middle-income countries sharing a set of favorable attributes (i.e., are members of the “club”) will converge to the income level of the richest countries.
Clustering Data analytics that focuses on sorting observations into groups (clusters) such that observations in a cluster are more similar to each other than they are to observations in other clusters
Coase Theorem states that if an externality can be traded and there are no transaction costs, then the allocation of property rights will be efficient and the resource allocation will not depend on the initial assignment of property rights.
Cobb-Douglas production function
Cointegrated - Describes two times series that have a long-term financial or economic relationship such that they don't diverge from each other without bound in the long run.
Collar A portfolio consisting of a long position in a put and a short position in a call, collaring the underlying security selling price to lie between the exercise prices of the two option contracts
Co-location (co-lo) - The act of locating trading algorithms next to a trading venue or in a site with very low latency connections to a trading venue in order to reduce overall end-to-end trade latency.
Commitment an obligation, typically the maximum amount that a limited partner agrees to invest in a fund.
Competitive markets The idea that two individual (or two countries) can both gain from trade even if one of them is better than the other at everything
Complex event processing (CEP) - A platform specifically designed for complex analysis and response to high-frequency data. CEP platforms typically include modeling tools, a CEP engine, and market data connectors.
Consumer choice theory is the branch of microeconomics that relates consumer demand
curves to consumer preferences
Consumer Confidence A measure of the degree of optimism of consumers about their future income and the future of economy; it is measured on the basis of surveys consumers. Is an important determinant of the consumption of aggregate demand.
Corner The purchase of a sufficient level of a given security to obtain market or monopoly power over its price
Convexity (1) The slope of the slope of a function (2) The sensitivity of the duration of a bond to changes in the market rate of interest.
Conditional Convergence
Cross-validation A set of model validation techniques that have the objective of controlling for bias in training data
The Current Account of the balance of payments comprises the balance of trade in goods and services plus net investment incomes from overseas assets and net transfers.
Cyclically balanced budget Occurs when the government runs a deficit during recessions and lean years but a surplus during periods of significant growth.
Cyclical Themes: occur at somewhat regular short or medium term intervals, typically based on changes in the business cycle. These cyclical trends can be mean-reverting, so that over a long period of time they tend to converge with some average level. Examples can include asset valuations, volatility, interest rates, and currency values.
Dark pools Trading venues that do not publish their liquidity and are only available to selected clients.
Data mining is the practice of finding forecasting models by searching through databases for correlations, patterns or trading rules.
Deadweight Loss: Surplus that is lost when a mutually beneficial trade no longer occurs, but would have under perfect competition.
Default risk The probability that a borrower defaults or fails to meet its obligation to make full and timely payments of principal and interest, according to the terms of the debt security.
Deflation A continuing (or sustained) decrease in the general price level
Depth A market's ability to process and execute a large order without substantantially impacting its price.
Diffusion index An index that measures how many indicators are pointing up and how many are pointing down
Direct market access (DMA) - A way for buy-side firms (such as hedge funds) to trade using the exchange membership of a sell-side firm. The buy-side firm sends the trades directly to market over a DMA connection to the sell-side firm. In this way, a buy-side firm can run its own proprietary algorithms without having to rely on or share knowledge with the sell-side firm. (See also “sponsored access.”)
Disinflation Refers to fall in the rate of inflation; it involves a positive rate of inflation and should be contrasted with deflation
Disposition effect As a result of loss aversion, an emotional bias whereby investors are reluctant to dispose of losers. This results in an inefficient and gradual adjustment to deterioration in fundamental value i.e. "Sell winners, hold losers"
The Dow Dividend approach (aka Dogs of Dow) The Dow Dividend approach sorts DJIA stock by
their dividend yields at the beginning of each year and then buys an equally-weighted portfolio of the
ten highest-yielding stocks. This strategy was popularized by Michael o'Higgins book with John
Downs, Beating the Dow, first published in 1991.
Dominant strategy A strategy (such as confessing in the Prisoners Dilemma) that generates the best
outcome for a player regardless of the other players' strategies.
Double inflection utility function - A utility function that changes based on levels of wealth.
Dummy variable - A type of qualitative variable that takes on a value of 1 if a particular condition is true and 0 if that condition is false.
Dutch Disease - A situation in which currency appreciation driven by strong export demand for resources makes other segments of the economy (particularly manufacturing) globally uncompetitive.
Econometrics - Branch of economics, designed for immediate statistical estimation and empirical application.
Efficient Market A market where security prices fully reflect all available information
Equity Risk Premium refers to the return of a broad index in excess over some nonequity alternatives
Equity premium puzzle refers to the difficulty of explaining the magnitude of the observed equity risk premium in the context of a standard macroeconomic model and rational expectations equilibrium.
Excess Return Used in various senses appropriate to context: 1) The difference between the portfolio return and the benchmark return; 2) The return in excess of the risk-free rate.
Execution algorithms - Execution algorithms operate on behalf of a trader to break down large orders intelligently to minimize market impact. They are typically used by or on behalf of buy-side institutions.
Equity Risk Premium refers to the return of a broad index in excess over some nonequity alternatives
Equity premium puzzle refers to the difficulty of explaining the magnitude of the observed equity risk premium in the context of a standard macroeconomic model and rational expectations equilibrium.
Excess Return Used in various senses appropriate to context: 1) The difference between the portfolio return and the benchmark return; 2) The return in excess of the risk-free rate.
Execution algorithms - Execution algorithms operate on behalf of a trader to break down large orders intelligently to minimize market impact. They are typically used by or on behalf of buy-side institutions.
Execution management system (EMS) - Software applications used by traders and designed to display market data and provide fast access to trading venues for transacting orders. They may also make local algorithms available or provide access to broker algorithms.
Extended portfolio assets and liabilities Assets and liabilities beyond those shown on a conventional balance sheet that are relevant in making asset allocation decisions; an example of an extended asset is human capital.
Factor Beta An asset’s sensitivity to a particular factor; a measure of the response of return to each unit of increase in a factor, holding all other factors constant.
Factor Models can be used in top down analysis to forecast returns based on sensitivities and risk factors. A random error has zero mean and uncorrelated with the factors.
Fallacy of composition Erroneous view that what is true for the individual (or the part) will also be true for the group (or the whole)
Fed funds rate The US interbank lending rate on overnight borrowings of reserves.
Federal Reserve System The central bank of the united States; it carries out banking regulatory policies and is responsible for the conduct of monetary policy
Free cash flow The actual cash that would be available to the company’s investors after making all investments necessary to maintain the company as an ongoing enterprise (also referred to as free cash flow to the firm); the internally generated funds that can be distributed to the company’s investors (e.g., shareholders and bondholders) without impairing the value of the company.
Free Rider Problem: When people can benefit from goods they don't produce or pay for.
Free Trade: International trade without any restrictions, tariffs, or quotas.
Filtration History or indexed set of sub objects in a stochastic process
Fisher effect The thesis that the real rate of interest in an economy is stable over time so that changes in nominal interest rates are the result of changes in expected inflation.
Gamma Sensitivity of an option's delta to changes in the price of the underlying security
Game Theory The study of strategy, decisions and outcomes in competitive situations.
Giffen goods Goods that are consumed more as the price of the good rises because it is a very inferior good whose income effect overwhelms its substitution effect when price changes.
Grinold–Kroner model An expression for the expected return on a share as the sum of an expected income return, an expected nominal earnings growth return, and an expected repricing return.
Hawks & Doves - Hawks worry about inflation. They believe there are costs associated with it. SO when hawks spy inflation, they argue for preemptive thinking. To ensure that inflation remains low and stable, they are willing to take the risk that the unemployment rate may not always be at its lowest sustainable level.
Doves, on the other hand, worry more about unemployment. They want to see monetary policy positioned to ensure that the economy achieves the highest sustainable level of employment. They might for example, be willing to tolerate inflation above the level associated with price stability for a while to avoid disrupting an economy already at full employment. And they might be more willing to risk some upturn in inflation to make sure that they had driven the unemployment rate to its lowest sustainable level.
Herding When a group of investors trade on the same side of the market in the same securities, or when investors ignore their own private information and act as other investors do.
Heteroskedacticity The property of having a non constant variance; refers to an error term with the property that its variance differs across observations.
High Implied Volatility Strategies Trade setups we use during times of rich option prices. We like to collect credit/sell premium, and hope for a contraction in volatilityHome-Country Bias
The favoring of domestic over non-domestic investments relative to global market value weights.
Homoskedacticity - The property of having a constant variance; refers to an error term that is constant across observations.
House Money Effect Refers to the tendency of individual investors to take on greater risks when investing with profits attained. This effect gets its name from the casino saying, ‘playing with the house's money’. This effect was first described by Richard Thaler and Eric J. Johnson of Cornell University.
High-frequency trading (HFT) algorithms High-frequency trading uses autonomous algorithms that analyze and respond to real-time market data to decide what, how, and when to trade. Typically, they are fast-moving algorithms that analyze thousands of market events per second and make sub-millisecond trading decisions. Often, the holding time for stocks is very short—potentially intra-day holding or even holding for only a few seconds! Examples of HTF Algo - Pairs Trading, Index Arbitrage, Basket Trading, Spread Trading, Mean Reversion and Delta Neutral Strategies
Implementation shortfall algorithm An algorithm that minimizes the trade-off between the market impact of immediately executing an order versus the risk of market drift if the order takes too long to execute.
Implied Volatility is not observable per se, but it is derived from an option pricing model—such as the Black–Scholes–Merton (BSM) model—and it is value that equates the model price of an option to its market price
Immunization is the process of constructing a portfolio that has, to first order, no interest rate risk
Index arbitrage Monitoring for breaks in the correlated relationships between instruments and the index of its sector (e.g., Ford against the automotive sector or a stock index future against one or more of its underlying component elements).
Insider trading A form of market abuse in which traders gain information that they should not be party to and trade using that information (e.g., good or bad news on a company).
Latency The time difference between stimulus and response. In a trading algorithm context, it is the amount of time from the market data being received, a pattern being identified, a decision being made, and trades being placed. In algorithmic trading, the lowest end-to-end latency possible is desirable.
Inflation indexes - Consumer price indexes reflect the prices of a basket of goods and services that is typically purchased by a normal household. Producer price indexes measure the cost of a basket of raw materials, intermediate inputs, and finished products. GDP deflators measure the price of the basket of goods and services produced within an economy in a given year. Core indexes exclude volatile items, such as agricultural products and energy, whose prices tend to vary more than other goods
International Fisher Effect - The proposition that nominal interest rate differentials across currencies are determined by expected inflation differentials.
Inter-temporal rate of substitution The ratio of the marginal utility of consumption s periods in the future (the numerator) to the marginal utility of consumption today (the denominator).
Inventory cycle is thought to be 2 to 4 years in length. It is often measured using the inventory to sales ratio. The measure increases when businesses gain confidence in the future of the economy and add to their inventories in anticipation of increasing demand for their output
Invisible hand Adam Smith's metaphor for how individual self-interest can lead to good outcomes for the group as a whole
Jensen's alpha Excess return on a portfolio over the CAPM-implied risk-adjusted return
Joint Probability if A, B, C,.. are statistically independent events, meaning that the probability of their occurring together is equal to the product of their individual probabilities. P(ABC..) is referred to as joint probability
Kinked demand curve A model developed to explain price inflexibility of oligopolistic firms that don't collude (do not agree to collaborate in order to limit competition between them)
Kurtosis A measure of how tall or flat the normal distribution is (2) the standardised fourth moment of a series; a measure of whether a series has ‘fat tails’.
Lasso (Least Absolute Shrinkage and Selection Operator) regression is a type of linear regression that uses shrinkage. Shrinkage is where data values are shrunk towards a central point, like the mean. The lasso procedure encourages simple, sparse models (i.e. models with fewer parameters). This particular type of regression is well-suited for models showing high levels of muticollinearity or when you want to automate certain parts of model selection, like variable selection/parameter elimination.
Law of large numbers A mathematical theorem that says repeating a bet large number of time is likely to produce an average outcome close to the expected value
Layering Using fictitious orders on one side of the market to manipulate algorithms to buy a real order on the other side of the market.
Leading Economic Indicators - A set of economic variables whose values vary with the business cycle but at a fairly consistent time interval before a turn in the business cycle.
Liability Driven Investing An investment industry term that generally encompasses asset allocation that is focused on funding an investor’s liabilities in institutional contexts.
Lognormal A variable's probability distribution is lognormal if the logarithm of the variable has a normal distribution
M1 (money supply) The sum of (1) currency in circulation (including coins) (2) checkable deposits held in depository institutions and (3) money market mutual fund shares
Machine learning Diverse approaches by which computers are programmed to improve performance in specified tasks with experience
Market fragmentation The development of multiple markets in a given asset class that each list the same instruments. For example, there are many US equities venues listing the same stocks.
Market impact The effect that a given transaction has on the market price of a security
Market microstructure Area of financial economics concerned with trading and market structure, market fairness, success and failure, and how the design of the market affects price formation and discovery.
Molodovsky Effect - The observation that P/Es tend to be high on depressed EPS at the bottom of a business cycle, and tend to be low on unusually high EPS at the top of a business cycle.
The P/E tends to rise during periods of economic expansion and to fall during recessions. A “high” P/E could be the result of a number of factors, including the following: falling real interest rates, a fall in the equity risk premium, an increase in the expectation of future real earnings growth, an expectation of lower operating and/or financial risk, or a combination of all of these factors. All of these components will be influenced by the business cycle.
Momentum crashes periods where 'losers' tend to outperform 'winners'
Mundell-Fleming Trilemma
- Countries generally evaluate three options in managing international monetary policy: fixed exchange rates, free flow of capital, and autonomous monetary policy.
- Mutual exclusivity dictates that only two of three options are achievable at a single time.
- In the modern day, most countries favor free flow of capital and autonomous monetary policy.
NAIRU (Non-Accelerating Inflation Rate of Unemployment) It is the minimum sustainable unemployment rate - the lowest unemployment rate that can be sustained without lifting inflation. The NAIRU is central to FOMC's decisions, since it sets the limits to where the unemployment rate should be pushed.
Naked access Where algorithmic trade orders do not pass through pre-trade risk controls, potentially leading to runaway executions
Nash Equilibrium: In game theory, a Nash Equilibrium occurs when each player has chosen a strategy that it will not want to change, given what the other players have chosen.
Natural Monopoly: A type of monopoly that occurs when fixed costs are incredibly high, which means average total cost is always dropping as output increases.
Negative Externality: In a mutually beneficial trade between two people (A and B), a negative externality occurs when a third party (person C) is negatively affected by the trade, but neither person A or B bear this cost.
Negative Rate is defined as the net payment made to keep money on deposit at a financial institution or payment of a net fee to invest in short-term instruments
Non-Excludable: When a firm can't prevent people from consuming the good without paying for it.
Non-Rival: When more than one person can consume the same unit of the good at same time.
Normal Goods: Goods you consume less of when your income goes down (alternatively, goods you consume more of when your income goes up).Nationally Recoginzed Statistical Rating Organization (NSSRO) A credit rating agency whose ratings the US SEC has designated as authoritative for certain regulatory purposes
Net asset value (NAV) Market value of a portfolio assets minus liabilities at a particular point in time divided by the number of shares in the portfolio outstanding at that time
Non-Deliverable Forwards Forward contracts that are cash settled (in the non-controlled currency of the currency pair) rather than physically settled (the controlled currency is neither delivered nor received).
No-load fund Mutual fund that accepts investments directly from investors without a sales charge
Offer A solicitation to sell (also called an ask)
Opaque markets Markets that lack transparency
Order driven markets Markets where traders can trade without the inter mediation of dealers
Order Protection Rule Provision from the 2007 NMS legislation that provides intermarket price priority for quotations that are immediately accessible
Out trades Trade reports filed with futures clearing firms or clearing houses with discrepancies resulting from recording errors, misunderstanding and fraud
Overconfidence bias People demonstrate unwarranted faith in their own intutive reasoning, judgements and/or cognitive abilities. Overcoming the bias - "Dont confuse brains with a bull market"
Paid-in Capital the amount of committed capital a limited partner has actually transferred to a
fund. Also known as the cumulative takedown amount.
Painting the tape A manipulative practice in which a trader continuously takes the best offer in the market in a particular instrument to drive the price up; then the trader sells a large quantity of the same instrument.
Partial Regression Coefficients - The slope coefficients in a multiple regression. Also called partial slope coefficients.
Pecking order hypothesis the notion from corporate finance that firms will select the cheapest method of financing (usually retained earnings) first before switching to increasingly more expensive forms
Personal consumption Household spending on consumer goods and services during the current period. Consumption is a flow concept
Portfolio Company a company that has received an investment from a private equity fund.
Positive Economics The scientific study of "what is" among economic relationships
Power of a test the ability of a test to correctly reject a wrong null hypothesis
Price ceiling A legally established maximum price that sellers may charge for a good or a resource
Price controls Government-mandated prices; they may be either greater or less than the market equilibrium price
Price deflator a series that measures the general level of prices in an economy, used to adjust a nominal series to a real one
Price discovery The process of determining the worth or price of an asset in the marketplace through the interactions of buyers and sellers
Price discrimination A practice whereby a seller charges different consumers different prices for the same product or service
Private Equity are firms that make range of investments ranging from investments in early stage companies (called a venture capital investment) to investments in mature companies (generally in a buyout transaction)
Probability distribution The mathematical description of how probable it is that the value of something is less than or equal to a particular level
Prompt month The front month - i.e the nearest expiring futures contract in commodities
Prospect Theory An alternative to expected utility theory, it assigns value to gains and losses (changes in wealth) rather than to final wealth, and probabilities are replaced by decision weights. In prospect theory, the shape of a decision maker’s value function is assumed to differ between the domain of gains and the domain of losses.
PPP - The idea that exchange rates move to equalize the purchasing power of different currencies.
Pseudo-random numbers a set of artifical random-looking numbers generated using a purely deterministic sequence
Psychographics is a qualitative methodology used to describe consumers on psychological attributes. Psychographics have been applied to the study of personality, values, opinions, attitudes, interests, and lifestyles
Quadruple witching refers to the third Friday of every March, June, September and December. On these days, market index futures, market index options, stock options and stock futures expire, usually resulting in increased volatility.
Qualified institutional buyer (QIB) Institution with an investment portfolio exceeding $100 million
Quantitative easing attempts to spur aggregate demand by drastically increasing the money supply.
Quote-driven markets Markets where dealers post quotes and participate on at least one side of every trade
Quote rule Formally referred to as SEC Rule 602 of Regulation NMS, requires that all market centers publicly disseminate their best bids and offers thought the securities information processors
Quote stuffing The placement of large numbers of rapid-fire stock orders, with most or all of which being canceled almost immediately, frequently for the purpose of clogging trading HFT and other algorithms and data computations
Random walk theory The theory that current stock prices already reflect known information about the future. Therefore, the future movement of stock prices will be determined by surprise occurrences. This will cause them to change in a random fashion
Real Interest Rate Parity - The proposition that real interest rates will converge to the same level across different markets.
Real Values Values that have been adjusted for the effects of inflation
Repo Rate The interest rate on a repurchase agreement.
Ricardian equivalence The view that a tax reduction financed with government debt will excert no impact on current consumption and aggregate demand because people will fully recognize the higher future taxes implied by the additional debt
Rule of 70 If a variable grows at a rate of x percent per year, 70/x will approximate the number of years required for the variable to double
Second movement the movements of a distribution define its shape; the second moment is another term for the variance of the data
Secondary effects Consequences of an economic change that are not immediately identifiable but are felt only with the passage of time
Sharpe ratio this is a risk-adjusted
Short squeeze is a situation in which a stock's price increase triggers a rush of buying activity among short sellers. Short sellers must buy stock to close out their short positions and cut their losses, which results in a further increase in stock prices, which compel still more short sellers to cover their positions.
Shrinkage estimator is a new estimate produced by shrinking a raw estimate (like the sample mean)
SKEW index - The SKEW index is a measure of potential risk in financial markets. Much like the VIX index, the SKEW index can be a proxy for investor sentiment and volatility.
Small firm effect - Evidence suggesting that small-cap stocks outperform large-cap stocks over time.
Social proof A bias in which individuals tend to follow the beliefs of a group (i.e. group think).
Soft Landing a soft landing occurs when growth slows - just as the economy reaches full employment - so the unemployment rate remains steady. If inflation is also low enough, at this point, the FOMC has achieved its two primary objectives - full employment and price stability
Spoofing Using fictitious limit orders to manipulate prices.
Spread duration A measure used in determining a portfolio’s sensitivity to changes in credit spreads.
Structural Themes: occur as one-off shifts that change an existing paradigm. These structural changes tend to be longer term in nature and are typically driven by powerful forces such as disruptive technologies or changing demographics and consumer behavior.
Steady state of growth - The constant growth rate of output (or output per capita) which can or will be sustained indefinitely once it is reached. Key ratios, such as the capital–output ratio, are constant on the steady-state growth path.
Stochastic process A sequence of random variables xt indexed by time t. In other words, a stochastic process is a random series of values xt sequenced over time
Supply shock An unexpected event that temporarily either increases or decreases aggregate supply
Supervised learning A machine learning approach that makes use of labeled training data
Survivorship bias - Bias that may result when failed or defunct companies are excluded from membership in a group.
Taylor Rule - A US economist, Professor John Taylor, devised a rule for setting policy rates, a rule that could help rate setters gauge whether their policy rate is at an “appropriate” level. This rule is known as the Taylor rule, and it takes the following form:
prt=lt+𝛑t+0.5(𝛑t−𝛑∗t)+0.5(Yt−Y∗t) =lt+1.5ι 𝛑 t−0.5𝛑∗t+0.5(Yt−Y∗t)
where prt is the policy rate at time t, lt is the level of real short-term interest rates that balance long-term savings and borrowing in the economy, 𝛑t is the rate of inflation, 𝛑∗t is the target rate of inflation, and Yt and Y∗t are, respectively, the logarithmic levels of actual and potential real GDP. The difference between Yt and Y∗t is known as the “output gap,” which is essentially measured in percentage terms.
Tax incidence Refers to the burden of tax, or those who are the ultimate payers of the tax
TED spread is an indicator of perceived credit risk in the general economy. TED is an acronym formed from US T-bill and ED, the ticker symbol for the eurodollar futures contract. The TED spread is calculated as the difference between Libor and the yield on a T-bill of matching maturity. An increase (decrease) in the TED spread is a sign that lenders believe the risk of default on interbank loans is increasing (decreasing). Therefore, as it relates to the swap market, the TED spread can also be thought of as a measure of counterparty risk. Compared with the 10-year swap spread, the TED spread more accurately reflects risk in the banking system, whereas the 10-year swap spread is more often a reflection of differing supply and demand conditions.
Theta Sensitivity of an option's price to changes in the option's time to expiry
Total Productivity Factor (TPF) - A multiplicative scale factor that reflects the general level of productivity or technology in the economy. Changes in total factor productivity generate proportional changes in output for any input combination. Y = A F(K,L) in this function A is the TPF.
Trade through The execution of an NMS stock trade at a price inferior to a protected quotation for that stock
Transition probabilities a square matrix of estimates of the likelihood that a markov switching variable will move from a given regime to each other regime
Treynor Ratio Index of risk-adjusted portfolio performance, calculated as the portfolio's excess return on the riskless rate relative to its beta
Unanticipated inflation An increase in general level of prices that was not expected by most decision makers
Unit root tests are tests for stationarity in a time series. A time series has stationarity if a shift in time doesn’t cause a change in the shape of the distribution; unit roots are one cause for non-stationarity.
Upstairs markets Markets where institutions trade securities directly among themselves. Also called fourth markets.
Unsupervised learning A machine learning approach that does not make use of labeled training data
Utility The subjective benefit or satisfaction a person expects from a choice or course of action
Utility Theory Theory whereby people maximize the present value of utility subject to a present value budget constraint.
Value Trap occurs when a value investor buys stock that looks undervalued but the business continues to deteriorate.
VaR an approach to measuring risk based on the loss on a portfolio that may be expected to occur with a given probability over a specific horizon
Veblen goods Goods that increase in desirability with increasing price.
Vega Sensitivity of an option's price to changes in the underlying security's standard deviation of returns.
Venture Capital An alternative management vehicle that invests capital in a private portfolio companies in development stages that have a strong potential for rapid growth
Vintage: the year that a private equity fund stops accepting new investors and begins to make
investments on behalf of those investors
VIX (the Fear Index) An implied of implied volatility of 30-day options on the S&P 500. A VIX reading of 20 indicates an expected annualized move of 20 percent in S&P 500 over the next 30 days. VIX hit an all-time high of ~90 in October 2008, after the Lehman Brothers collapse. VIX tends to trade between 10 and 20 during periods of complacence and shoots up amid market winners
Volatility the extent to which a series is highly variable over time, usually measured by its standard deviation or variance
Volatility Clustering The tendency for large (small) swings in prices to be followed by large (small) swings of random direction.
Volatility Skew refers to the difference in implied volatility of each opposite, equidistant option. The current volatility skew in the market results in puts trading richer than calls, because the IV in OTM puts is higher than the equivalent OTM calls. Velocity also attributes to the skew, since markets can fall much faster than they rise. Before the crash of 1987, this skew did not exist.
Volatility Smile The U-shaped plot (of implied volatility (y-axis) against strike price (x-axis) for options on the same underlying with the same expiration) that occurs when the implied volatilities priced into both OTM puts and calls trade at a premium to implied volatilities of ATM options.
Weakly stationary process has a fixed mean and varaiance but no other structure (e.g. it has zero autocorrelations for all lags). The error term in a regression model is usually assumed to be white noise
Winner's Curse Problem occurring when the winning bidder bids the most, and is the most likely to have bid too much for the auctioned object
Yield curves show how the yields on bonds vary as the term to maturity increases.
Yield to maturity The internal rate of return of a bond
Zero cost collar A collar where the time zero proceeds from the call sale exactly offsets the cost of the put purchase. The options' exercise prices are set so that the call and the put have the same values
Zone of Insolvency