Return distribution predictability and its implications for portfolio selection

The inquiries to return predictability are traditionally limited to conditional mean, while literature on portfolio selection is replete with moment-based analysis with up to the fourth moment being considered. This paper develops a distribution-based framework for both return prediction and portfolio selection. More specifically, a time-varying return distribution is modeled through quantile regressions and copulas, using quantile regressions to extract information in marginal distributions and copulas to capture dependence structure. A preference function which captures higher moments is proposed for portfolio selection. An empirical application highlights the additional information provided by the distributional approach which cannot be captured by the traditional moment-based methods.

Evaluating the Predictability of the Volatility Smile Using Return Distributions

In this paper, we examine the predictability of observed volatility smiles in three major European index options markets, utilising the historical return distributions of the respective underlying assets. The analysis involves an application of the Black (1976) pricing model adjusted in accordance with the Jarrow-Rudd methodology as proposed in 1982. Thereby we adjust the expected future returns for the third and fourth central moments as these represent deviations from normality in the distributions of observed returns. Thus, they are considered one possible explanation to the existence of the smile. The obtained results indicate that the inclusion of the higher moments in the pricing model to some extent reduces the volatility smile, compared with the unadjusted Black-76 model. However, as the smile is partly a function of supply, demand, and liquidity, and as such intricate to model, this modification does not appear sufficient to fully capture the characteristics of the smile.

Mechanisms of variability and predictability of the tropical coupled ocean-atmosphere system

A conceptual model is proposed to explain the observed aperiodicity in the short term climate fluctuations of the tropical coupled ocean-atmosphere system. This is based on the evidence presented here that the tropical coupled ocean-atmosphere system sustains a low frequency inter-annual mode and a host of higher frequency intra-seasonal unstable modes. At long wavelengths, the low frequency mode is dominant while at short wavelengths, the high frequency modes are dominant resulting in the co-existence of a long wave low frequency mode with some short wave intra-seasonal modes in the tropical coupled system. It is argued that due to its long wavelength, the low frequency mode would behave like a linear oscillator while the higher frequency short wave modes would be nonlinear. The conceptual model envisages that an interaction between the low frequency linear oscillator and the high frequency nonlinear oscillations results in the observed aperiodicity of the tropical coupled system. This is illustrated by representing the higher frequency intra-seasonal oscillations by a nonlinear low order model which is then coupled to a linear oscillator with a periodicity of four years. The physical mechanism resulting in the aperiodicity in the low frequency oscillations and implications of these results on the predictability of the coupled system are discussed.

Lyapunov exponents and predictability of the tropical coupled ocean-atmosphere system

It has recently been proposed that the broad spectrum of interannual variability in the tropics with a peak around four years results from an interaction between the linear low-frequency oscillatory mode of the coupled system and the nonlinear higher-frequency modes of the system. In this study we determine the Lyapunov exponents of the conceptual model consisting of a nonlinear low-order model coupled to a linear oscillator for various values of the coupling constants.

Multi-scale interactions and predictability of the Indian summer monsoon

Following the seminal work of Charney and Shukla (198 1), the tropical climate is recognised to be more predictable than extra tropical climate as it is largely forced by 'external' slowly varying forcing and less sensitive to initial conditions. However, the Indian summer monsoon is an exception within the tropics where 'internal' low frequency (LF) oscillations seem to make significant contribution to its interannual variability (IAV) and makes it sensitive to initial conditions. Quantitative estimate of contribution of 'internal' dynamics to IAV of Indian monsoon is made using long experiments with an atmospheric general circulation model (AGCM) and through analysis of long daily observations. Both AGCM experiments and observations indicate that more than 50% of IAV of the monsoon is contributed by 'internal' dynamics making the predictable signal (external component) burried in unpredictable noise (internal component) of comparable amplitude. Better understanding of the nature of the 'internal' LF variability is crucial for any improvement in predicition of seasonal mean monsoon. Nature of 'internal' LF variability of the monsoon and mechanism responsible for it are investigated and shown that vigorous monsoon intraseasonal oscillations (ISO's) with time scale between 10-70 days are primarily responsible for generating the 'internal' IAV. The monsoon ISO's do this through scale interactions with synoptic disturbances (1-7 day time scale) on one hand and the annual cycle on the other. The spatial structure of the monsoon ISO's is similar to that of the seasonal mean. It is shown that frequency of occurance of strong (weak) phases of the ISO is different in different seasons giving rise to stronger (weaker) than normal monsoon. Change in the large scale circulation during strong (weak) phases of the ISO make it favourable (inhibiting) for cyclogenesis and gives rise to space time clustering of synoptic activity. This process leads to enhanced (reduced) rainfall in seasons of higher frequency of occurence strong (weak) phases of monsoon ISO.

Electrical breakdown of carbon nanotube devices and the predictability of breakdown position

We have investigated electrical transport properties of long (>10 mu m) multiwalled carbon nanotubes (NTs) by dividing individuals into several segments of identical length. Each segment has different resistance because of the random distribution of defect density in an NT and is corroborated by Raman studies. Higher is the resistance, lower is the current required to break the segments indicating that breakdown occurs at the highly resistive segment/site and not necessarily at the middle. This is consistent with the one-dimensional thermal transport model. We have demonstrated the healing of defects by annealing at moderate temperatures or by current annealing. To strengthen our mechanism, we have carried out electrical breakdown of nitrogen doped NTs (NNTs) with diameter variation from one end to the other. It reveals that the electrical breakdown occurs selectively at the narrower diameter region. Overall, we believe that our results will help to predict the breakdown position of both semiconducting and metallic NTs. Copyright 2012 Author(s). This article is distributed under a Creative Commons Attribution 3.0 Unported License. http://dx.doi.org/10.1063/1.4720426]

TURBULENT PUMPING OF MAGNETIC FLUX REDUCES SOLAR CYCLE MEMORY AND THUS IMPACTS PREDICTABILITY OF THE SUN'S ACTIVITY

Prediction of the Sun's magnetic activity is important because of its effect on space environment and climate. However, recent efforts to predict the amplitude of the solar cycle have resulted in diverging forecasts with no consensus. Yeates et al. have shown that the dynamical memory of the solar dynamo mechanism governs predictability, and this memory is different for advection- and diffusion-dominated solar convection zones. By utilizing stochastically forced, kinematic dynamo simulations, we demonstrate that the inclusion of downward turbulent pumping of magnetic flux reduces the memory of both advection- and diffusion-dominated solar dynamos to only one cycle; stronger pumping degrades this memory further. Thus, our results reconcile the diverging dynamo-model-based forecasts for the amplitude of solar cycle 24. We conclude that reliable predictions for the maximum of solar activity can be made only at the preceding minimum-allowing about five years of advance planning for space weather. For more accurate predictions, sequential data assimilation would be necessary in forecasting models to account for the Sun's short memory.

Predictability and chaotic nature of daily streamflow

The predictability of a chaotic series is limited to a few future time steps due to its sensitivity to initial conditions and the exponential divergence of the trajectories. Over the years, streamflow has been considered as a stochastic system in many approaches. In this study, the chaotic nature of daily streamflow is investigated using autocorrelation function, Fourier spectrum, correlation dimension method (Grassberger-Procaccia algorithm) and false nearest neighbor method. Embedding dimensions of 6-7 obtained indicates the possible presence of low-dimensional chaotic behavior. The predictability of the system is estimated by calculating the system’s Lyapunov exponent. A positive maximum Lyapunov exponent of 0.167 indicates that the system is chaotic and unstable with a maximum predictability of only 6 days. These results give a positive indication towards considering streamflow as a low dimensional chaotic system than as a stochastic system.

Predictability and chaotic nature of daily streamflow

The predictability of a chaotic series is limited to a few future time steps due to its sensitivity to initial conditions and the exponential divergence of the trajectories. Over the years, streamflow has been considered as a stochastic system in many approaches. In this study, the chaotic nature of daily streamflow is investigated using autocorrelation function, Fourier spectrum, correlation dimension method (Grassberger-Procaccia algorithm) and false nearest neighbor method. Embedding dimensions of 6-7 obtained indicates the possible presence of low-dimensional chaotic behavior. The predictability of the system is estimated by calculating the system's Lyapunov exponent. A positive maximum Lyapunov exponent of 0.167 indicates that the system is chaotic and unstable with a maximum predictability of only 6 days. These results give a positive indication towards considering streamflow as a low dimensional chaotic system than as a stochastic system.

Predictability of nonstationary time series using wavelet and EMD based ARMA models

Research has been undertaken to ascertain the predictability of non-stationary time series using wavelet and Empirical Mode Decomposition (EMD) based time series models. Methods have been developed in the past to decompose a time series into components. Forecasting of these components combined with random component could yield predictions. Using this ideology, wavelet and EMD analyses have been incorporated separately which decomposes a time series into independent orthogonal components with both time and frequency localizations. The component series are fit with specific auto-regressive models to obtain forecasts which are later combined to obtain the actual predictions. Four non-stationary streamflow sites (USGS data resources) of monthly total volumes and two non-stationary gridded rainfall sites (IMD) of monthly total rainfall are considered for the study. The predictability is checked for six and twelve months ahead forecasts across both the methodologies. Based on performance measures, it is observed that wavelet based method has better prediction capabilities over EMD based method despite some of the limitations of time series methods and the manner in which decomposition takes place. Finally, the study concludes that the wavelet based time series algorithm can be used to model events such as droughts with reasonable accuracy. Also, some modifications that can be made in the model have been discussed that could extend the scope of applicability to other areas in the field of hydrology. (C) 2013 Elesvier B.V. All rights reserved.

Evolution-induced catastrophe and its predictability

Both earthquake prediction and failure prediction of disordered brittle media are difficult and complicated problems and they might have something in common. In order to search for clues for earthquake prediction, the common features of failure in a simple nonlinear dynamical model resembling disordered brittle media are examined. It is found that the failure manifests evolution-induced catastrophe (EIC), i.e., the abrupt transition from globally stable (GS) accumulation of damage to catastrophic failure. A distinct feature is the significant uncertainty of catastrophe, called sample-specificity. Consequently, it is impossible to make a deterministic prediction macroscopically. This is similar to the question of predictability of earthquakes. However, our model shows that strong stress fluctuations may be an immediate precursor of catastrophic failure statistically. This might provide clues for earthquake forecasting.