1 November 1994Financial Analysts JournalVolume 50, Issue 6
When Is a Tree a Hedge?
Joseph J. Mezrich
Linear models dominate quantitative thinking in investments. The weighted sum of a relevant set of factors, typically determined from a regression or discriminant analysis, determines model expectation. This approach is quite different from the heuristic style of decision making people tend to prefer. For example, when a patient is admitted to a trauma center, the attending physician determines the course of treatment for the emergency by going through a set of hierarchical decisions. Some things are more important than others, and they get considered first. Is there a pulse? is clearly a question to be asked first. Then follow questions of decreasing significance in deciding the course of treatment for the patient. The decision model for the physician is a decision tree, with an appropriate set of "if -then" rules. The decision tree is determined in a heuristic fashion based on experience and is preferred to a quantitative, weighted-sum approach, as in regression or discriminant analysis. The best investment decision making is more along the lines of using the right decision tree than using the right linear model.
Read the Complete Article in Financial Analysts Journal
Financial Analysts Journal
CFA Institute Member ContentPublisher Information
Association for Investment Management and Research
7 pages doi.org/10.2469/faj.v50.n6.75ISSN/ISBN: 0015-198X
Functional cookies, which are necessary for basic site functionality like keeping you logged in, are always enabled.