According to Fischer, the crash was well within his broadened conception of equilibrium with costly information and noise trades. A couple of years later, Fischer (“the theorist”) would eventually team up with Bob Litterman (“the econometrician”) working out on the Black-Litterman asset allocation model. The idea was to blend the passive market portfolio with the active view portfolio based on ex ante expected deviation of performance from equilibrium, using the international CAPM to estimate the expected returns. Besides, the solution to blend the theoretical equilibrium allocations with the client’s view was to treat both as independent measures of an unknown parameter; each one measured subject to error, and then calculate the best combined estimate. The Goldman Sachs asset management adopted this model which was improved later on extending it to include equities and finding other uses such as running it backwards or either using it as a tool for risk control.
In 1994, Fischer had some health issues ,by the way, shifting his focus to sum up his life’s work.
B for Neo - some choppiness in your sentences.
ReplyDeleteLitterman was in the academic world at the start of a movement in econometrics to reduce structure. The idea was that we imposed to much structure from theory onto the data, so that the data has to fit the theory. By imposing less structure, you could see whether what was left fit the theory, or if you had just been making it fit the theory. Litterman would have been a famous economist, but instead he chose to be a richly compensated quant.