Mastering Python for Finance - Second Edition

The 2k factorial design

When designing experiments for backtesting, we can consider the use of 2k factorial design. Suppose we have two factors, A and B. Each factor behaves as a Boolean value, with values of either +1 or -1. A +1 value indicates a quantitatively high value, while -1 indicates a low value. This gives us a combination of 2² = 4 outcomes. For a 3-factor model, this gives us a combination of 2³ = 8 outcomes. The following table illustrates an example with two factors with outcomes W, X, Y, and Z:

	A	B	Replication I
Value	+1	+1	W
Value	+1	-1	X
Value	-1	+1	Y
Value	-1	-1	Z

Note that we are generating one replication of backtest to produce a set of outcomes. Performing additional ...