The return provided by an asset is a function of the uncertainty or risk associated with the financial investment. An equity investment implies, for example, assuming a company's business risk, and a bond investment implies assuming default risk.
To the extent that specific risk characteristics predict returns, identifying and forecasting the behavior of these risk factors becomes a primary focus when designing an investment strategy. It yields valuable trading signals and is the key to superior active-management results. The industry's understanding of risk factors has evolved very substantially over time and has impacted how ML is used for algorithmic trading.
Modern Portfolio Theory (MPT) introduced ...
