Transcription
Quantitative Investment AnalysisCharacteristics vs. RiskFall 2020
Some Excerpts from the TextbookChapter 11 of DeFusco, McLeavey, Pinto, and Runkle. 2015. Quantitative InvestmentAnalysis 3e.
Premises of (Most) Early PortfoliosRisk return: in an efficient market
IntuitionIngredients of building portfolios (non-exhaustive) lots of risky assets free access to risk-free assetto diversify away (hedge against) idiosyncratic (non-systematic) riskAs a resultChapter 11 of DeFusco, McLeavey, Pinto, and Runkle. 2015. Quantitative InvestmentAnalysis 3e.Put it differently Anything that correlates to expected returns must be a proxy forthe exposure to certain risk.IEven the length of the nose of a newborn elephant in South Africa
Size and Book-to-marketCited by 24,154
Argument
If assets are priced rationally .
Motivation
Although ad hoc .
Common VariationIdentifying common variations among stocks is what most assetpricing models do, and the only thing that they can do.
CharacteristicsHeated DebateAre characteristics proxies for risk? Or they are just characteristics.To dispute risk explanations provide alternative explanationsI mostly behavioral biases induced trading activities break the tie between characteristics and covariance structureI orthogonalization challenge the magnitude of risk premiaI inconsistencidfes between observed risk premia and model impliedrisk premia
OverreactionCited by 10,020
ExtrapolationCited by 6,136
Assumptions Market in weak form efficiency Unsophisticated (retail/naive) investors Sophisticated (institutional/contrarian) investors
Size and Book-to-market, again .Cited by 2,575
Attack from another Angle
Factor Orthogonal to EverythingA priced factor need to be orthogonal to everything else, not only tothe market, yet affects future returns.Empirically difficult to prove or reject.
Instead
In a Nutshell
Back to the Textbook I Might not be fruitful I Might be dangerous I Real competitiveness I Redundant section
Quantitative Investment Analysis Characteristics vs. Risk Fall 2020. Some Excerpts from the Textbook Chapter 11 of DeFusco, McLeavey, Pinto, and Runkle. 2015. Quantitative Investment Analysis 3e. Premises of (Most) Early Portfolios Risk ,return: in an efficient market. Intuition Ingredients of building portfolios (non-exhaustive) lots of risky assets free access to risk-free asset to .
