From Stanford to Miami: Teaching Finance with Portfolio123 — My CAPM Test Study

[yuvaltaylor]

@Jrinne

Do you still use elliptical trimming (or Cook’s Distance) at times? Seems like there might be a case for considering it here as well — given the high leverage of the outliers in this data.

Yes, I do. For anything performance-based, I measure alpha by plotting against the benchmark and then using elliptical trimming.

@Jrinne

I think it’s fine to remove (trim), or Winsorize points — but it’s worth pausing to consider why those points are there in the first place:

• Is it noise trading? If so, that might offer insight into behavioral finance.
• Is it non-linearity that could be exploited with a different model — especially if other quants are overlooking it?
• Is it heteroskedasticity, in which case an inverse-variance regression might be the right tool? That’s a standard approach for handling this issue and would likely smooth out the regression line without discarding the data.

Was that generated by an AI bot or did you write it? Anyway, the reason these points are there in the first place is because financial return data has fat tails (and heteroskedasticity is one way of saying that). I have not been able to figure out what an inverse-variance regression involves, and when I asked ChatGPT about it, it started making stuff up. If you have a method to implement inverse-variance regression in Excel, I'd be glad to try it. Like I said, the reason I use elliptical trimming rather than DFFITS is that it's easier for me.