W.Buffett's Investment Strategy: Cash as a Call Option

This research will attempt to illuminate the phenomenon of Warren Buffett, in particular, his investment strategy. Being one of the most successful investors, Buffett is known as the owner of largest cash reserves. It’s also widely believed that he has no market timing ability, as he does not try to build his portfolio based on expectations about market movements. However, he still manages to make remarkable deals when markets are severely depressed that appear like cases of market timing. Therefore, the main purpose of this study is to answer the question: «Does Warren Buffett has the ability to forecast macroeconomic behavior or his impressive results can be explained by another features of his investment style?» In this research, we consider standard methodology of Treynor-Mazuy and Henriksson-Merton in order to investigate the presence of Buffett’s ability to time the market. We will also consider our new methodology, which assumes that cash can be considered as a call option and represents the strategy of buying stocks when they are cheap and keeping cash when there are no opportunities for investment. In this case, we will compare the value of cash, which represents the ability to buy assets at lower price with opportunity cost from holdings this asset by modeling future market condition via Monte Carlo method. Our results indicate that strategy of holdings cash reserves is more profitable in case of Warren Buffett, which mean that he has the market timing ability. These findings can be applied by both investors and academics either to test the markets efficiency hypothesis or to implement the strategy in order to gain return. Keywords: Warren Buffett, time series, investment strategy, microforecasting and macroforecasting, market timing, cash, call option.