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PRACTICAL APPLICATIONS OF THE HIERARCHY OF EMPIRICAL EVIDENCE IN FINANCE


 * MARCOS LÓPEZ DE PRADO

Practical Applications

 24 January 2024
doi

10.3905/pa.2024.pa587

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THE JOURNAL OF PORTFOLIO MANAGEMENT VOL 49 ISSUE 9

Volume 49, Issue 9
Quantitative Tools 2023
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ABSTRACT

In The Hierarchy of Empirical Evidence in Finance, from the September 2023 issue
of The Journal of Portfolio Management, Marcos López de Prado of the Abu Dhabi
Investment Authority explains that investment professionals should place varying
degrees of confidence in investment strategies based on the type of evidence on
which they are based. Greater confidence should be placed in strategies based on
falsifiable theories that embody a causal mechanism explaining how a given
factor produces a result. Less confidence should be placed in strategies based
merely on observed associations (correlations) among events that might or might
not have any causal relationship to one another. The author explains that
strategies grounded on 1) expert opinions, 2) case studies, or 3) econometric
studies generally lack scientific rigor in specifying a falsifiable causal
mechanism to explain how they work. Scientific rigor is generally present in
strategies based on either simulated interventions or natural experiments, both
of which embody the formal use of falsifiable theories.

 1. Marcos López de Prado
    1. is the global head of quantitative research & development at Abu Dhabi
       Investment Authority, a professor of practice in the School of
       Engineering at Cornell University, and a professor of practice in the
       Department of Mathematics at Khalifa University in Abu Dhabi, United Arab
       Emirates. (marcos.lopezdeprado@adia.ae)

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