## Linear Factor Models in FinanceThe 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 | |

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 |

277 | |

### Common terms and phrases

algorithm approach Arbitrage Pricing Theory asset returns assume assumption attributes autocorrelated average F test Bayesian beta-sorted portfolios book-to-market factor canonical CAPM coefficients conditional constraints correlation country and sector country factors covariance matrix Economics empirical equally weighted excess equation equity estimates excess market return excess return expected returns F distribution factor analysis factor exposures factor loadings factor returns Financial framework hedge fund implied volatility indices individual assets investment investors Journal of Finance kurtosis linear factor model macroeconomic managers market capitalization market factor misspecification Monte Carlo Integration MSCI multivariate F test multivariate normal distribution noncentral normal distribution p-value parameters posterior pricing errors pricing models prior problem regression residual return series risk model scaled factor sensitivity significant size-sorted portfolios skewness stochastic discount factor stock returns Table test statistics value-weighted excess market variables variance variance-covariance matrix weighted excess market zero β β

### Popular passages

Page ii - Presenting cutting-edge research to the professional/practitioner market • Combining intellectual rigour and practical application • Covering the interaction between mathematical theory and financial practice • To improve portfolio performance, risk management and trading book performance • Covering quantitative techniques Market Brokers/Traders; Actuaries; Consultants; Asset Managers; Fund Managers; Regulators; Central Bankers; Treasury Officials; Technical Analysts; and Academics for Masters...

### References to this book

Active Alpha: A Portfolio Approach to Selecting and Managing Alternative ... Alan H. Dorsey No preview available - 2007 |