factor models and return
DESCRIPTION
TRANSCRIPT
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FACTOR MODELS
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FACTOR MODELS AND RETURN-GENERATING PROCESSES
• FACTOR MODELS– DEFINITION: a model of a return-generating
process that relates returns on securities to the movement of one or more common factors
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FACTOR MODELS AND RETURN-GENERATING PROCESSES
• FACTOR MODELS– assume returns of two securities are correlated
in some way
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FACTOR MODELS AND RETURN-GENERATING PROCESSES
• FACTOR MODELS– any unexplained aspects of a return are
assumed to be• unique
• uncorrelated with the unique aspect of other securities
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THE MARKET MODEL
• THE MARKET MODEL– is a specific example of a factor model– the general form may be written
r i = i, I i, I ri, I
where the factor is the market index (I)
r i is the i th return in the market
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THE MARKET MODEL
• TWO IMPORTANT FEATURES OF THE ONE-FACTOR MODEL– THE TANGENCY PORTFOLIO– DIVERSIFICATION
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MULTIPLE-FACTOR MODELS
• MULTIPLE FACTOR MODELS– use more than one explanatory variable in the
return-generating process
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MULTIPLE-FACTOR MODELS
• MULTIPLE-FACTOR MODELS– some of these factors may include
• THE GROWTH RATE OF GDP
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MULTIPLE-FACTOR MODELS
• MULTIPLE-FACTOR MODELS– some of these factors may include
• THE LEVEL OF INTEREST RATES
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MULTIPLE-FACTOR MODELS
• MULTIPLE-FACTOR MODELS– some of these factors may include
• THE YIELD SPREAD BETWEEN CERTAIN VARIABLES
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MULTIPLE-FACTOR MODELS
• MULTIPLE-FACTOR MODELS– some of these factors may include
• THE INFLATION RATE
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MULTIPLE-FACTOR MODELS
• MULTIPLE-FACTOR MODELS– some of these factors may include
• THE LEVEL OF OIL PRICES
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MULTIPLE-FACTOR MODELS
• SECTOR-FACTOR MODELS– Assumption:
• prices may move together for the same industry or economic sector
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MULTIPLE-FACTOR MODELS
• SECTOR-FACTOR MODELS– sectors possible
• utilities
• transportation
• financial
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ESTIMATING FACTOR MODELS
• THREE METHODS– TIME-SERIES APPROACH– CROSS-SECTIONAL APPROACH– FACTOR-ANALYTIC APPROACH
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ESTIMATING FACTOR MODELS
• TIME-SERIES APPROACH– BEGINNING ASSUMPTIONS:
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ESTIMATING FACTOR MODELS
• TIME-SERIES APPROACH– BEGINNING ASSUMPTIONS:
• investor knows in advance of the factors that influence a security's returns
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ESTIMATING FACTOR MODELS
• TIME-SERIES APPROACH– BEGINNING ASSUMPTIONS:
• investor knows in advance of the factors that influence a security's returns
• the information may be gained from an economic analysis of the firm
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ESTIMATING FACTOR MODELS
• CROSS-SECTIONAL APPROACH– BEGINNING ASSUMPTION
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ESTIMATING FACTOR MODELS
• CROSS-SECTIONAL APPROACH– BEGINNING ASSUMPTION
• Identify Attributes: estimates of a security’s sensitivities to certain factors
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ESTIMATING FACTOR MODELS
• CROSS-SECTIONAL APPROACH– BEGINNING ASSUMPTION
• Identify Attributes: estimates of a security’s sensitivities to certain factors
• estimate attributes in a particular period of time
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ESTIMATING FACTOR MODELS
• CROSS-SECTIONAL APPROACH– BEGINNING ASSUMPTION
• Identify Attributes: estimates of a security’s sensitivities to certain factors
• estimate attributes in a particular period of time
• repeat over multiple time periods to estimate the factor’s standard deviations and correlations
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ESTIMATING FACTOR MODELS
• FACTOR-ANALYTIC APPROACH– BEGINNING ASSUMPTIONS:
• neither factor values nor securities attributes are known
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ESTIMATING FACTOR MODELS
• FACTOR-ANALYTIC APPROACH– BEGINNING ASSUMPTIONS
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ESTIMATING FACTOR MODELS
• FACTOR-ANALYTIC APPROACH– BEGINNING ASSUMPTIONS:
• neither factor values nor security’s attributes are known
• uses factor analysis approach
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ESTIMATING FACTOR MODELS
• FACTOR-ANALYTIC APPROACH– BEGINNING ASSUMPTIONS:
• neither factor values nor security’s attributes are known
• uses factor analysis approach
• take the returns over many time periods from a sample to identify one or more significant factors generating covariances