Encyclopedia of Financial Models, 3 Volume Set

Multifactor Equity Risk Models and Their Applications

FRANK J. FABOZZI, PhD, CFA, CPA

Professor of Finance, EDHEC Business School

RAMAN VARDHARAJ, CFA

Vice President, OppenheimerFunds

FRANK J. JONES, PhD

Professor, Accounting and Finance Department, San Jose State University and Chairman, Investment Committee, Private Ocean Wealth Management

Abstract: Multifactor equity risk models are classified as statistical models, macroeconomic models, and fundamental models. The most popular types of models used in practice are fundamental models. Many of the inputs used in a multifactor risk model are those used in traditional fundamental analysis. There are several commercially available fundamental multifactor risk models. There are asset management companies that develop proprietary models. Brokerage firms have developed models that they make available to institutional clients.

Quantitative-oriented common stock portfolio managers typically employ a multifactor equity risk model in constructing and rebalancing a portfolio and then for evaluating performance. The most popular type of multifactor equity risk model used is a fundamental factor model.1 While some asset management firms develop their own model, most use commercially available models. In this entry we use one commercially available model to illustrate the general features of fundamental models and how they are used to construct portfolios. In our illustration, we will use an old version of a model developed by Barra (now ...