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Assessing multivariate predictors of financial market movements: A latent factor framework for ordinal data

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Author Info

  • Philippe HUBER

    (University of Geneva)

  • Olivier SCAILLET

    (University of Geneva, HEC and Swiss Finance Institute)

  • Maria-Pia VICTORIA-FESER

    (University of Geneva)

Abstract

Much of the trading activity in Equity markets is directed to brokerage houses. In exchange they provide so-called “soft dollars” which basically are amounts spent in “research” for identifying profitable trading opportunities. Soft dollars represent about USD 1 out of every USD 10 paid in commissions. Obviously they are costly, and it is interesting for an institutional investor to determine whether soft dollar inputs are worth being used (and indirectly paid for) or not, from a statistical point of view. To address this question, we develop association measures between what broker-dealers predict and what markets realize. Our data are ordinal predictions by two broker-dealers and realized values on several markets, on the same ordinal scale. We develop a structural equation model with latent variables in an ordinal setting which allows us to test broker-dealer predictive ability of financial market movements. We use a multivariate logit model in a latent factor framework, develop a tractable estimator based on a Laplace approximation, and show its consistency and asymptotic normality. Monte Carlo experiments reveal that both the estimation method and the testing procedure perform well in small samples. The method is then used to analyze our dataset.

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Bibliographic Info

Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 08-45.

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Length: 41 pages
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Handle: RePEc:chf:rpseri:rp0845

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Web page: http://www.SwissFinanceInstitute.ch
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Related research

Keywords: latent variable; generalized linear model; factor analysis; multinomial logit; forecasts; LAMLE; Laplace approximation.;

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Cited by:
  1. Cai, Jing-Heng & Song, Xin-Yuan & Lam, Kwok-Hap & Ip, Edward Hak-Sing, 2011. "A mixture of generalized latent variable models for mixed mode and heterogeneous data," Computational Statistics & Data Analysis, Elsevier, vol. 55(11), pages 2889-2907, November.

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