Conceptual framework


Harry Markowitz (Nobel Prize of Economics), in its well-known article "Portfolio selection" published in 1952, demonstrated from the theoretical point of view that investors, acting in a rational way, will select those portfolios maximizing profitability and minimizing the risks to take. Supposing profitability and risk combinations from all the possible portfolios correspond to the blue area of the following graphic. An investor provided with a portfolio offering the attended profitability and risk from portfolios C, D or E would not be at a rational situation as he could have a portfolio with a higher profitability and the same level of risk or a portfolio with the same level of profitability but lower risk. Hence, investors will choose those portfolios between points A and B which will be referred as “Efficient Frontier”. This way, an investors’ utility function (generally non-lineal function) that depends positively from profitability and negatively from risk is defined. In this case, those investors loving risk would choose point A and those ones averse to risk would locate at point be
.

Let’s now suppose that, in addition, investors have the possibility of invest in fixed income assets that provide profitability at zero risk (Rf). Investors will be able to invest a part of their wallet in Fixed Income and the other part in variable income, thus, positioning themselves at an assets combination along the straight line from G to M. Nevertheless if Investors’ mood is studied, it is remarkable that they do not always follow the same utility function as, whenever there is an optimistic or happy moment, investors tend to take higher risks becoming more tolerant to the last and, whenever there is a pessimistic, fearful or sad moment, investors become more conservative and show a higher level of aversion to risk.

Consequently, before an event that causes optimism among investors, the last would choose a higher risk portfolio as T1 that has a higher percentage of variable income than fixed income, what implies stock purchase and, thus, an increase in shares price. In contrast, in fear or panic moments investors tend to maintain lower risk investment portfolios and, consequently, lower percentage of variable income investments positioning themselves at point T2 or even at point G, what would imply shares sale and, thus, a decline of stock prices.

¿What factors cause changes on investors’ mood and, thus, the selection of more aggressive (when tolerant to risk) or more conservative (when averse to risk) investment portfolio? Financial markets anomalies have been detected as a consequence of sports results, calendar, weather or even moon phases.

On the basis of this conceptual framework, if, thanks to big data, we are able to measure investors’ mood we would be able to anticipate to stock exchange trends and, consequently, obtain absolute yields beating the market.

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