Recent economic turmoil has left many with large investment losses. While nobody can predict the magnitude and the timing of the next crash, you can be better prepared if the right steps are taken to protect your portfolio from hidden risk. We will explore the myths and realities of today’s investment world with an emphasis on how to avoid getting hurt by the hidden risks in the stock market. We will also develop a practical set of rules for managing risks in personal finance.

Recommended Books

“The Black Swan” by Nassim Taleb:
http://www.amazon.com/Black-Swan-Impact-Highly-Improbable/dp/1400063515/ref=sr_1_1?ie=UTF8&qid=1305338621&sr=8-1

Exerpt from “The Black Swan” on the Bell Curve (Chapter 16. The Bell Curve, That Great Intellectual Fraud): http://www.fooledbyrandomness.com/GIF.pdf

“Fooled by Randomness” by Nassim Taleb:
http://www.amazon.com/Fooled-Randomness-Hidden-Chance-Markets/dp/1400067936/ref=ntt_at_ep_dpt_2

“Misbehavior of Markets” by Benoit Mandelbrot:
http://www.amazon.com/Misbehavior-Markets-Fractal-Financial-Turbulence/dp/0465043577/ref=sr_1_1?ie=UTF8&s=books&qid=1305338801&sr=1-1

“Investment Management: Portfolio Diversification, Risk, and Timing–Fact and Fiction” Robert L. Hagin:
http://www.amazon.com/Investment-Management-Portfolio-Diversification-Timing-Fact/dp/0471469203/ref=sr_1_1?ie=UTF8&s=books&qid=1305338860&sr=1-1

Recommended Articles

“Mild vs. Wild Randomness: Focusing on those Risks that Matter” by Benoit Mandelbrot:
http://www.gendercare.com/download/PHP/download.php?fname=./mildvswild.pdf

“Scaling in financial prices,” I – IV, by Benoit Mandelbrot:
http://users.math.yale.edu/~bbm3/web_pdfs/tailsAndDependence.pdf

http://users.math.yale.edu/~bbm3/web_pdfs/multifractalsAndTheStarEquation.pdf

http://users.math.yale.edu/~bbm3/web_pdfs/cartoonBrownianMotions.pdf

http://users.math.yale.edu/~bbm3/web_pdfs/multifractalConcentration.pdf

“A focus on the exceptions that prove the rule” by Nassim Taleb and Benoit Mandelbrot:
http://www.ft.com/intl/cms/s/2/5372968a-ba82-11da-980d-0000779e2340.html

“The risks of severe infrequent events” by Nassim Taleb:
http://www.fooledbyrandomness.com/thebanker.pdf

“A crash course in investing: six lessons from the market meltdown” by Dougal Williams:
http://www.advisorperspectives.com/articles/2009/08/18/a-crash-course-in-investing-six-lessons-from-the-market-meltdown

“The Mistakes We Make and Why We Make Them” by Meir Statman:
http://online.wsj.com/article/SB10001424052970204313604574326223160094150.html

“Beyond Gaussian averages: redirecting international business and management research toward extreme events and power laws” by Pierpaolo Andrian:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=983084

H. E. Stanley (Boston University) Workshop Talk at Conference in Argentina (modern analysis showing S&P scalability):
http://polymer.bu.edu/~hes/econophysics/pasi06eco.pdf

“What are Stock Investors’ Actual Historical Returns? Evidence from Dollar-Weighted Returns,” by Ilia D. Dichev:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=544142

Portfolio/Retirement Simulators

Monte Carlo (Gaussian) (note: these may not work on Firefox/Safari browsers):
http://www.flexibleretirementplanner.com/java/LaunchFRPWeb.html

http://www.moneychimp.com/articles/volatility/montecarlo.htm

A simple, yet powerful calculator (Monte Carlo) using actual historical data developed by Vanguard:
https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementNestEggCalc.jsf

For Further Reading

[1] Backtesting, flawed studies (many studies done incorrectly).

Amit Goyal and Ivo Welch “A Comprehensive Look at The Empirical Performance of Equity Premium Prediction”: link

[2] Mechanical filters and trading strategies (no consistent evidence in the past decade, more studies needed).

The Profitability of Technical Analysis: A Review: link

[3] Mean reversion (no consistent evidence).

The Long-Term Risks of Global Stock Markets, Philippe Jorion: link

[4] Fallacy of time diversification.

http://www.norstad.org/finance/risk-and-time.html

[5] Power law/non-Gaussian, fat tails.

Mandelbrot, B., “The Variation of Certain Speculative Prices”: link
Gabaix et al., Power Laws in Economics and Finance: link

[6] Multifractal Model of Asset Returns.

Mandelbrot, Fisher & Calvet 1997, “A Multifractal Model of Asset Returns”: link

[7] Black Sholes is wrong.

“Why We Have Never Used the Black-Scholes-Merton Option Pricing Formula”: link
Costless Collar paper (asymetry in options pricing): link

[8] Can history be used to predict the future?

Analysis can not predict earnings accurately. Even if you were able to predict earnings, profiting may be impossible (see page 75) of “Investment Management: Portfolio Diversification, Risk, and Timing–Fact and Fiction”: link

You are also welcome to read other articles on my blog:
http://litovskymanagement.com/articles