Linear Factor Models in Finance

Front Cover
John Knight
Elsevier, Dec 1, 2004 - Business & Economics - 304 pages
The determination of the values of stocks, bonds, options, futures, and derivatives is done by the scientific process of asset pricing, which has developed dramatically in the last few years due to advances in financial theory and econometrics. This book covers the science of asset pricing by concentrating on the most widely used modelling technique called: Linear Factor Modelling.

Linear Factor Models covers an important area for Quantitative Analysts/Investment Managers who are developing Quantitative Investment Strategies. Linear factor models (LFM) are part of modern investment processes that include asset valuation, portfolio theory and applications, linear factor models and applications, dynamic asset allocation strategies, portfolio performance measurement, risk management, international perspectives, and the use of derivatives.

The book develops the building blocks for one of the most important theories of asset pricing - Linear Factor Modelling. Within this framework, we can include other asset pricing theories such as the Capital Asset Pricing Model (CAPM), arbitrage pricing theory and various pricing formulae for derivatives and option prices.

As a bare minimum, the reader of this book must have a working knowledge of basic calculus, simple optimisation and elementary statistics. In particular, the reader must be comfortable with the algebraic manipulation of means, variances (and covariances) of linear combination(s) of random variables. Some topics may require a greater mathematical sophistication.

* Covers the latest methods in this area.
* Combines actual quantitative finance experience with analytical research rigour
* Written by both quantitative analysts and academics who work in this area
 

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Contents

1 Review of literature on multifactor asset pricing models
1
2 Estimating UK factor models using the multivariate skew normal distribution
12
3 Misspecification in the linear pricing model
30
4 Bayesian estimation of risk premia in an APT context
61
5 Sharpe style analysis in the MSCI sector portfolios a Monte Carlo integration approach
83
6 Implication of the method of portfolio formation on asset pricing tests
95
7 The small noise arbitrage pricing theory and its welfare implications
150
8 Risk attribution in a global countrysector model
159
9 Predictability of fund of hedge fund returns using DynaPorte
202
10 Estimating a combined linear factor model
210
11 Attributing investment risk with a factor analytic model
226
12 Making covariancebased portfolio risk models sensitive to the rate at which markets reflect new information
249
13 Decomposing factor exposure for equity portfolios
262
Index
277
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About the author (2004)

Stephen Satchell is a Fellow of Trinity College, the Reader in Financial Econometrics at the University of Cambridge and Visiting Professor at Birkbeck College, City University Business School and University of Technology, Sydney. He provides consultancy for a range of city institutions in the broad area of quantitative finance. He has published papers in many journals and has a particular interest in risk.

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