MODEL PERFORMANCE MEASURES FOR LEVERAGED INVESTORS

Craig Friedman () and Sven Sandow ()
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Craig Friedman: Standard & Poor's, Risk Solutions Group, 55 Water Street, New York, NY 10041, USA;
Sven Sandow: Standard & Poor's, Risk Solutions Group, 55 Water Street, New York, NY 10041, USA;

International Journal of Theoretical and Applied Finance (IJTAF), 2004, vol. 07, issue 05, 541-554

Abstract: We measure the performance of probabilistic models from a decision-theoretic perspective along the lines of Friedman and Sandow [6]. In particular, we adopt the point of view of an investor who evaluates models based on the test-sample averaged utility of the expected-utility-optimal strategies that the models suggest in the horse race setting. In this paper, we relax the assumptions of Friedman and Sandow [6]: we omit the notion of a "true" measure and we allow our investor to withhold or borrow cash, which widens the range of possible applications. We show that, in this setting, our relative model performance measure is odds-ratio independent if and only if the investor has a generalized logarithmic utility function, in which case it essentially reduces to the likelihood ratio. We also show that for horse races with nearly homogeneous returns, our relative performance measure is approximately equal to the likelihood ratio.

Keywords: Likelihood ratio; utility function; model performance; horse race; financial market (search for similar items in EconPapers)
Date: 2004
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Citations: View citations in EconPapers (2)

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DOI: 10.1142/S0219024904002530

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