STANDARD DEVIATION IN THE BUSINESS WORLD

Standard Deviations in the Business World Elizabeth Achhammer and Karima Diggs-Holmes University of Phoenix Quantitative Reasoning for Business/QRB 501 August 5, 2013 Saba Tahmassebi

STANDARD DEVIATIONS IN THE BUSINESS WORLD Purpose of the Study There has been a financial crisis happening around the world over the last decade. It is important to understand why and what is impacting the financial crisis and how it can be improved. Black Swans in this study are events that were the Achilles heel of financial models. There are usually 25 standard deviations evens that happen several days in a row. The purpose of this study is to discuss the implications of black swan events in asset pricing and risk management. Black Swan events disappears for S&P Index returns are measured relative to standard deviation of the conditional S&P distribution. In this study a one day lagged VIX is used to provide an understandable measure of conditional S&P standard deviation (Marsh & Pfeiderer, 2012). The Research Question How did economists and others get it so wrong and what can be done to change it? Have risk modelers created an industry whose intense technical debates with each other lead gullible outsiders to believe that this is a profession with genuine expertise? Hypothesis "Extant models that properly encompass predictable shifts in investment risk ameliorate

much of the alleged "black swan" problem and securities markets do in fact seem to be attuned to the risk of rare economic disasters and "price in" their risk"(Marsh & Pfeiderer, 2012, p 2).

STANDARD DEVIATIONS IN THE BUSINESS WORLD Main Findings The first finding is in the presence of significant model specification risk and estimation risk, decisions made by averse decision makers are more conservative rather than aggressive. Investors want to protect themselves against the black swan risk and may purchase insurance to help with the risk, but will still lose some. The most accurate way of minimizing the loss is to update information on a regular basis and in a timely manner. There are extant models that account much better for the extreme events in security returns observed over an amount of time than the black swan. These include having order of magnitude seen in the recent financial crisis. The probabilities are given by mixtures of probability distributions that account for degrees of intensity in the flow of economic events at different times. Case 2 Purpose of the Study The purpose of this study was to test Linnemans trade rule and the Sharpe ratio.

Researchers were trying to identify whether or not negative residuals on property were the result of undervaluation, causing an opportunity to make extra profits. The rationale of the trade rule suggests property price adjustment is a function of the market and is related to the value of the neighborhoods physical characteristics. Research Question Is there an opportunity to earn excess profits on undervalued properties based on the assumption of inefficiency in the market?

STANDARD DEVIATIONS IN THE BUSINESS WORLD Hypothesis The risk-adjusted return performance is significantly different on undervalued property, creating an opportunity to earn excess returns. Findings This study used data from a sample of apartment building sales in Vancouver, Canada. Mean excess returns (appreciation return less the risk-free interest rate), the standard deviation of excess returns and the corresponding Sharpe ratio are calculated for each portfolio. Using the Sharpe ratio adjusts the portfolio returns for risk (standard deviation of returns) before they are compared. The Sharpe ratios are tested to determine whether they are statistically significantly different ((Londerville, 1998, p.11).

After the comparisons were made, it was clear none of the Sharpe ratios differed more than 10%, making the null hypothesis true.

STANDARD DEVIATIONS IN THE BUSINESS WORLD Reference Londerville, J. (1998). A Test of a Buying Rule for "Underpriced" Apartment Buildings. Real Estate Economics, 26(3), 537-553. Marsh, T., & Pfeiderer, P. (-2012). "Black Swans" and the Financial Crisis. Review of Pacific Financial -Markets & Policies, 19(2), 1250008-1-1250008-12.