EAGER: ON BUILDING A BRIDGE BETWEEN CLASSICAL CONTROL THEORY AND FINANCIAL MARKETS:

University Of Wisconsin-Madison, Madison WI

Investigators

Abstract

Objective: The proposal deals with feedback control based methods for investment in lieu of the traditional financial models. The goal is to exploit the properties of feedback which do not require elaborate price modeling. Consistent with basic feedback principles, the controllers are reactive to price rather than predictive in nature. Intellectual Merit: The research will stimulate the application of feedback principles in finance as an alternative to economic modeling. Rather than using unreliable stochastic price models, we treat price as an external uncontrolled input against which we seek robust performance. The feedback controller simply processes the history of price and possibly volume to determine the appropriate level of investment. In a portfolio context, controller design will result in new alternatives to the celebrated Markowitz theory for weighting of various components. The proposed research includes the notion of robust certification of performance in a so-called idealized market. The approach is to replace expensive and time consuming back-tests with a new robustness paradigm for evaluating investment strategies. Broader Impact: The research plans to develop simple recipes and software for the self-directed investor who is in essence competing against well capitalized hedge funds and large financial institutions that can afford to take risky bets with potentially high payoffs. We envision workshops for non-experts aimed to teach attendees how to manage investments, a web site from which tutorial literature and trading codes can be readily downloaded. This line of research has the potential to motivate a new generation of graduate students in systems engineering to consider careers in finance.