Intelligent Finance Component I – Financial Information Fusion

1. Second International Workshop on Intelligent Finance (IWIF-II) 6.-8. July 2007, Chengdu, China Intelligent FinanceComponent I – Financial Information Fusion Prof Dr PAN Heping, Director of PRC, IIFP, SIIF & SSFI Prediction Research Centre (PRC) University of Electronic Science &Technology of China （UESTC） International Institute for Financial Prediction (IIFP), Finance Research Centre of ChinaSouthwestern University of Finance & Economics (SWUFE) Swingtum Institute of Intelligent Finance (SIIF)Swingtum School of Financial Investment (SSFI) Room 340/306 Yifu Building, Chengdu 610054, China Phone：+8628-83208728, Mobile：13908085966 Email: panhp@uestc.edu.cn, h.pan@iifp.net URL Chinese：www.swingtum.com.cn URL English： www.swingtum.com

2. Second International Workshop on Intelligent Finance (IWIF-II) 6.-8. July 2007, Chengdu, China Intelligent FinanceComponent I – Financial Information Fusion 潘和平 （博士、教授、长江学者） 电子科技大学预测研究中心主任 西南财经大学中国金融研究中心国际金融预测研究所所长 形势冲智能金融研究院院长 & 形势冲金融投资学校校长 成都市建设北路二段四号逸夫楼340/306 电话：028-83208728, 手机：13908085966 电子邮件: panhp@uestc.edu.cn, h.pan@iifp.net 中文网站：www.形势冲.com, www.swingtum.com.cn 英文网站：www.swingtum.com

3. Contents • A Departure from the Fundamental Law of Active Management • Problems of Financial Information Fusion • Multiple Perspectives of Financial Market Analysis • The Pyramid of Financial Market Analysis • A Framework of Financial Information Fusion • Financial Information Flow Chart – DAG and DBN • A List of Economic, Fundamental and Technical Factors • Economic Indicators Most Sensitive to US Stocks, Bonds and $ • An Illustrative Model of Business Cycle, Stock Market Cycleand Sector Rotation • Examples of Intermarket Influences • Examples of Economic Indicators Co-movement • A Part of Information Fusion Platform – Projection of Future Events www.swingtum.com/institute/IWIF

4. 1. A Departure from the Fundamental Law of Active Management According to Grinod-Kahn Fundamental Law of Active Management In order to exploit all the legally available information, the logical starting line of Intelligent Finance must be to map out all the information flows through the whole loop of financial market analysis, investment decision, and trading control. The aim of financial information fusion is to maintain a consistent comprehensive picture of the global financial markets of interest on multiple time frames. However, the economic and/or fundamental factor models for forecasting asset returns in line with the APT and portfolio theory are all linear, to be consistent with the EMT. Information flows were always assumed to be one-step immediate transmission without intermediate processes. Intelligent Finance believes in the nonlinearity and complexity of information transmission processes, taking into the full consideration the heterogeneity, differences, incompleteness and imperfectness of investors’ understanding and reaction to even the same pieces of information. www.swingtum.com/institute/IWIF

5. Grinod-Kahn (1995-2000) definitions • Active Management: The pursuit of investment returns in excess of a specified benchmark. • IR – Information Ratio: The ratio of annualized expected residual return to residual risk, a central measurement for active management. Value added is proportional to the square of the information ratio. • IC – Information Coefficient: The correlation of forecast returns with their subsequent realizations. A measure of skill. • Breadth: The number of independent forecasts available per year. A stock picker forecasting returns to 100 stocks every quarter exhibits a breadth of 400 if each forecast is independent (based on separate information). www.swingtum.com/institute/IWIF

6. 2. Problems in Financial Information Fusion For this endeavour we face problems such as • Multiple Information Sources • Multiple Analysis Perspectives • Multiple Levels of Time Scale • Multiple Classes of Assets • Multiple Types of Markets • Multiple Nations and Regions Leading to • Many Profitable Opportunities • Many Sources of Risks • Too Many Things to Consider • Where Do We Start and End? • How Do We Streamline Information, Decision and Control? www.swingtum.com/institute/IWIF

7. 3. Multiple Perspectives of Financial Markets • Fundamental AnalysisValue, Growth, Price, Margin of Safety, Market Shocks, Business Cycles, Industry Trends and Life Cycles, Competitive Advantage, Management Quality, Financial Health and Efficiency … • Technical AnalysisPrice, Index, Trend, Market Cycles, Price Waves, Swings & Momentum, Support & Resistance, Market Timing, Time Frames, Volatility Breakout, Stop Loss, Trendline Break, Trend Reversal … • Strategic AnalysisVenture Capital, Public Listing, Liquidation, Market Makers, Accumulation, Lifting, Distribution, Dumping, Currencies-Stocks-Bonds, Takeover, Macrowave Investing, Conscious Reflexivity Process Investing, Market Catalysts, “Shark School”, “Wolf Pack”, Stop Running Game, … • Mental AnalysisSurvival of the Fittest, Your Personalized Trading System, Trade your System Carefree, Follow your System Religiously www.swingtum.com/institute/IWIF

8. 4. The Pyramid of Financial Market Analysis Strategic Analysis Scale Gap Mental Analysis Psychological Gap Technical Analysis Marketplace Gap Fundamental Analysis www.swingtum.com/institute/IWIF

9. 5. A Framework of Financial Information Fusion Strategic Intelligence Market Maker Situation &Intent Stock Price Prediction Stock Price Situation Analysis Market Activity Events Sector Situation Analysis Politico-Economic Events Strong vs Weak Stocks Market Situation Analysis Trading System Market Price Data Company Value & Growth Sector Index Prediction Company Fundamentals Industry Cycle & Sector Rotation Fiscal Policy Interest Rate & Yield Curve Market Index Prediction Macroeconomic Indexes Growth Trend & Business Cycle www.swingtum.com/institute/IWIF

10. 6. Financial Information Flow Chart – Directed Acyclic Graph, Dynamic Bayesian Networks Economic Factors Economic Factors Forecast Fundament Factors Fundament Factors Forecast Technical Factors Technical Factors Forecast Asset Returns Asset Returns Forecast Portfolio Weights New Portfolio Weights www.swingtum.com/institute/IWIF

11. 7. A List of Economic, Fundamental, and Technical Factors (Ref: L.B. Chincarini & D. Kim, 2006) • Economic Factors- Consumption Growth - Commodity Prices- Corporate Bond Spread - Real GDP Growth- Industrial Production - Slope of Yield Curve- Inflation - Unemployment Rate • Fundamental Factors- Valuation - Solvency- Operating Efficiency- Operating Profitability- Financial Risk- Liquidity Risk • Technical Factors- Price-Based- Volume-Based- Overall Market Movement • Alternative Factors- Analyst- Corporate Finance Policy- Social Responsibility www.swingtum.com/institute/IWIF

12. 8a. Economic Indicators Most Sensitive to US Stocks(Bernard Baumhohl, 2006) www.swingtum.com/institute/IWIF

13. 8b. Economic Indicators Most Sensitive to US Bonds(Bernard Baumhohl, 2006) www.swingtum.com/institute/IWIF

14. 8c. Economic Indicators Most Influential to US $(Bernard Baumhohl, 2006) www.swingtum.com/institute/IWIF

15. Stock Market Sectors1 – Transportation 2 – Technology 3 – Capital Goods 4 – Basic Industries and Materials 5 – Energy 6 – Food, Drugs, Health Care 7 – Utilities 8 – Financials 9 – Autos, Housing, Consumer Cyclicals 9. An Illustrative Modelof Business Cycle, Stock Market Cycle and Sector Rotation (ref: Navarro 2004 and macroeconomics textbooks) Business Cycle Stock Market Cycle Peak Top 6 5 4 Bear Bull Recession 3 7 2 Expansion 8 1 9 Bottom Trough Bottom Trough time www.swingtum.com/institute/IWIF

16. 120. Examples of Intermarket Influence Dynamics www.swingtum.com/institute/IWIF

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21. 11. Examples of Economic Indicators Co-movement (Ref: www.martincapital.com) www.swingtum.com/institute/IWIF

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23. 12. A Part of Information Fusion Platform – Projection of Future Events (ref: money.cnn.com) www.swingtum.com/institute/IWIF

24. The End of Intelligent Finance Component I – Financial Information Fusion Thank you for your attention! www.swingtum.com/institute/IWIF