Friday, April 1, 2011

Bond Market as a Casino Game Part 1

With this post, I am doing something I try very hard to avoid, especially when communicating to my clients, and that is blurring the line between investing and gambling.  But after reading all of Reuven Brenner’s books and finishing Ralph Vince Leverage Space Trading Model, I think blurring the line can offer additional insights and methods not traditionally available.

As a starting point, let’s apply basic probability methods on the most widely used bond index Barclays Aggregate Total Return to test my belief that the 1980-current bull run in bonds has offered one of the best games ever for any investor in the history of the markets (see my post “Bonds Tumble and Questions Start Getting Asked”).  In the Microsoft Excel pivot table shown below, the Barclays Aggregate has been up 70% of all month since 1980, and the up months generate on average 1.44% return compared to the down months –1.02%.  If we put this in casino terms, it is like winning 7 of every 10 games with a payout of 1.4 to 1.


For another look, let’s use R and PerformanceAnalytics to see the histogram and boxplot.

From TimelyPortfolio

source:Barclays Capital and thanks to the fine contributors to R and PerformanceAnalytics

Now that we have the basic probabilities secured, we can have all sorts of fun in later posts with the Leverage Space techniques and Monte Carlo simulations.


R code:


#load index data given as date and total return value

#convert to monthly return series for PerformanceAnalytics
#use discrete ROC to get simple monthly return
#((value this month-value last month)/value last month)-1

par(mfrow=c(2,1)) #2 rows and 1 column
chart.Histogram(BarAggReturn["1980::"],main="Barclays Aggregate Total Return Monthly % Histogram since 1980",cex.main=1,xlab=NULL,breaks=15,methods="add.centered")
chart.Boxplot(BarAggReturn["1980::"],main="Barclays Aggregate Total Return Monthly % Boxplot since 1980",cex.main=1,xlab=NULL,names=FALSE)


  1. Not being as fluent in calculable returns, where does the LBUSTRUU bond fund lie in respect to a % of one's portfolio, especially given the Euro/US difficulties, given that Corporates lie somewhere in the 17-18% makeup of this index?


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  3. I can only count to 26... 36 numbers in the roulette :D