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Quantitative Equity Portfolio Management

Book Description

Quantitative Equity Portfolio Management brings the orderly structure of fundamental asset management to the often-chaotic world of active equity management. Straightforward and accessible, it provides you with nuts-and-bolts details for selecting and aggregating factors, building a risk model, and much more.

Table of Contents

  1. Cover Page
  2. Quantitative Equity Portfolio Management: An Active Approach to Portfolio Construction and Management
  3. Copyright Page
  4. CD Page
  5. Contents
  6. Foreword
  7. Preface
  8. Notations and Abbreviations
  9. I An Overview of QEPM
    1. 1 The Power of QEPM
      1. 1.1 Introduction
      2. 1.2 The Advantages of QEPM
      3. 1.3 Quantitative and Qualitative Approaches to Similar Investment Situations
      4. 1.4 A Tour of the Book
      5. 1.5 Conclusion
    2. 2 The Fundamentals of QEPM
      1. 2.1 Introduction
      2. 2.2 QEPM α
        1. 2.2.1 Benchmark α
        2. 2.2.2 CAPM α
        3. 2.2.3 Multifactor α
        4. 2.2.4 A Variety of a’s
        5. 2.2.5 Ex-Ante and Ex-Post α
        6. 2.2.6 Ex-Ante and Ex-Post Information Ratio
      3. 2.3 The Seven Tenets of QEPM
      4. 2.4 Tenets 1 and 2: Market Efficiency and QEPM
        1. 2.4.1 The Efficient-Market Hypothesis
        2. 2.4.2 Anomalies
        3. 2.4.3 Market Efficiency and QEPM
      5. 2.5 Tenets 3 and 4: The Fundamental Law, The Information Criterion, and QEPM
        1. 2.5.1 The Truth about the Fundamental Law
        2. 2.5.2 The Information Criterion
        3. 2.5.3 Information Loss
      6. 2.6 Tenets 5, 6, and 7: Statistical Issues in QEPM
        1. 2.6.1 Data Mining
        2. 2.6.2 Parameter Stability
        3. 2.6.3 Parameter Uncertainty
      7. 2.7 Conclusion
    3. 3 Basic QEPM Models
      1. 3.1 Introduction
      2. 3.2 Basic QEPM Models and Portfolio Construction Procedures
        1. 3.2.1 Factor Choice
        2. 3.2.2 The Data Decision
        3. 3.2.3 Factor Exposure
        4. 3.2.4 Factor Premium
        5. 3.2.5 Expected Return
        6. 3.2.6 Risk
        7. 3.2.7 Forecasting
        8. 3.2.8 Security Weighting
      3. 3.3 The Equivalence of the Basic Models
      4. 3.4 The Screening and Ranking of Stocks with the Z-Score
      5. 3.5 Hybrids of the Models and the Information Criterion
        1. 3.5.1 The Setup
        2. 3.5.2 The Z-Score Model
        3. 3.5.3 A Hybrid of the Z-Score Model and a Fundamental Factor Model
        4. 3.5.4 Information Loss
      6. 3.6 Choosing the Right Model
        1. 3.6.1 Consistency with Economic Theory
        2. 3.6.2 Ability to Combine Different Types of Factors
        3. 3.6.3 Ease of Implementation
        4. 3.6.4 Data Requirement
        5. 3.6.5 Intuitive Appeal
      7. 3.7 Conclusion
  10. II Portfolio Construction and Maintenance
    1. 4. Factors and Factor Choice
      1. 4.1 Introduction
      2. 4.2 Fundamental Factors
        1. 4.2.1 Valuation Factors
        2. 4.2.2 Solvency Factors
        3. 4.2.3 Operating Efficiency Factors
        4. 4.2.4 Operating Profitability Factors
        5. 4.2.5 Financial Risk Factors
        6. 4.2.6 Liquidity Factors
      3. 4.3 Technical Factors
      4. 4.4 Economic Factors
      5. 4.5 Alternative Factors
        1. 4.5.1 Analyst Factors
        2. 4.5.2 Corporate Finance Policy Factors
        3. 4.5.3 Social Responsibility Factors
      6. 4.6 Factor Choice
        1. 4.6.1 Univariate Regression Tests
        2. 4.6.2 Multiple Regression Tests
        3. 4.6.3 Unidimensional Zero-Investment Portfolio
        4. 4.6.4 Multidimensional Zero-Investment Portfolio
        5. 4.6.5 Techniques to Reduce the Number of Factors
      7. 4.7 Conclusion
    2. Appendix 4A: Factor Definition Tables
    3. 5. Stock Screening and Ranking
      1. 5.1 Introduction
      2. 5.2 Sequential Stock Screening
      3. 5.3 Sequential Screens Based on Famous Strategies
      4. 5.4 Simultaneous Screening and the Aggregate Z-Score
        1. 5.4.1 The Z-Score
        2. 5.4.2 The Aggregate Z-Score
        3. 5.4.3 Ad Hoc Aggregate Z-Score
        4. 5.4.4 Optimal Aggregate Z-Score
        5. 5.4.5 Factor Groups and the Aggregate Z-Score
      5. 5.5 The Aggregate Z-Score and Expected Return
        1. 5.5.1 Expected Return Implied by the Z-Score
        2. 5.5.2 The Forecasting Rule of Thumb
        3. 5.5.3 The Equivalence between the Z-Score Model and the Fundamental Factor Model
      6. 5.6 The Aggregate Z-Score and the Multifactor α
      7. 5.7 Conclusion
    4. Appendix 5A: A List of Stock Screens Based on Well-Known Strategies
    5. Appendix 5B: On Outliers
    6. 6. Fundamental Factor Models
      1. 6.1 Introduction
      2. 6.2 Preliminary Work
        1. 6.2.1 Choosing Factors
        2. 6.2.2 Treatment of the Risk-Free Rate
        3. 6.2.3 Choosing the Time Interval and Time Period
        4. 6.2.4 Choosing the Universe of Stocks
      3. 6.3 Benchmark and α
      4. 6.4 Factor Exposure
      5. 6.5 The Factor Premium
        1. 6.5.1 OLS Estimator of the Factor Premium
        2. 6.5.2 Robustness Check
        3. 6.5.3 Outliers and MAD Estimator of Factor Premium
        4. 6.5.4 Heteroscedasticity and GLS Estimator of the Factor Premium
      6. 6.6 Decomposition of Risk
      7. 6.7 Conclusion
    7. 7 Economic Factor Models
      1. 7.1 Introduction
      2. 7.2 Preliminary Work
      3. 7.3 Benchmark and α
      4. 7.4 The Factor Premium
        1. 7.4.1 Factor Premium for Economic/Behavioral/Market Factors
        2. 7.4.2 Factor Premium for Fundamental/Technical/ Analyst Factors
        3. 7.4.3 Factor Premium for Statistical Factors
      5. 7.5 Factor Exposure
        1. 7.5.1 The Standard Approach
        2. 7.5.2 When the Standard Approach Fails
      6. 7.6 Decomposition of Risk
        1. 7.6.1 The Standard Approach
        2. 7.6.2 When the Standard Approach Fails
      7. 7.7 Conclusion
    8. 8 Forecasting Factor Premiums and Exposures
      1. 8.1 Introduction
      2. 8.2 When Is Forecasting Necessary?
      3. 8.3 Combining External Forecasts
      4. 8.4 Model-Based Forecast
      5. 8.5 Econometric Forecast
      6. 8.6 Parameter Uncertainty
      7. 8.7 Forecasting the Stock Return
      8. 8.8 Conclusion
    9. 9 Portfolio Weights
      1. 9.1 Introduction
      2. 9.2 Ad Hoc Methods
      3. 9.3 Standard Mean-Variance Optimization
        1. 9.3.1 No Constraints
        2. 9.3.2 Short-Sale and Diversification Constraints
        3. 9.3.3 Sector or Industry Constraints
        4. 9.3.4 Trading-Volume Constraint
        5. 9.3.5 Risk-Adjusted Return
      4. 9.4 Benchmark
      5. 9.5 Ad Hoc Methods Again
      6. 9.6 Stratification
      7. 9.7 Factor-Exposure Targeting
      8. 9.8 Tracking-Error Minimization
        1. 9.8.1 Direct Computation
        2. 9.8.2 Tracking by Factor Exposure
        3. 9.8.3 Ghost Benchmark Tracking
        4. 9.8.4 Risk-Adjusted Tracking Error
      9. 9.9 Conclusion
    10. Appendix 9A: Quadratic Programming
      1. 9A.1 Quadratic Programming with Equality Constraints
      2. 9A.2 A Numerical Example
      3. 9A.3 Quadratic Programming with Inequality Constraints
      4. 9A.4 A Numerical Example
    11. 10 Rebalancing and Transactions Costs
      1. 10.1 Introduction
      2. 10.2 The Rebalancing Decision
        1. 10.2.1 Rebalancing and Model Periodicity
        2. 10.2.2 Change in α and Other Parameters
      3. 10.3 Understanding Transactions Costs
      4. 10.4 Modeling Transactions Costs
      5. 10.5 Portfolio Construction with Transactions Costs
        1. 10.5.1 The Optimal Portfolio with Transactions Costs
        2. 10.5.2 The Tracking Portfolio with Transactions Costs
      6. 10.6 Dealing with Cash Flows
        1. 10.6.1 Reducing Transactions Cost Using Futures and ETFs
        2. 10.6.2 Rebalancing toward Optimal Target Weights
      7. 10.7 Conclusion
    12. Appendix 10A: Approximate Solution to the Optimal Portfolio Problem
    13. 11 Tax Management
      1. 11.1 Introduction
      2. 11.2 Dividends, Capital Gains, and Capital Losses
      3. 11.3 Principles of Tax Management
      4. 11.4 Dividend Management
      5. 11.5 Tax-Lot Management
      6. 11.6 Tax-Lot Mathematics
      7. 11.7 Capital Gain and Loss Management
      8. 11.8 Loss Harvesting
        1. 11.8.1 Loss Harvesting and Reoptimizing
        2. 11.8.2 Loss Harvesting and Characteristic Matching
        3. 11.8.3 Loss Harvesting with a Benchmark
      9. 11.9 Gains from Tax Management
      10. 11.10 Conclusion
  11. III α Mojo
    1. 12 Leverage
      1. 12.1 Introduction
      2. 12.2 Cash and Index Futures
        1. 12.2.1 Theoretical Bounds of Leverage
        2. 12.2.2 Leverage Mechanics
        3. 12.2.3 Expected Return and Risk
      3. 12.3 Stocks, Cash, and Index Futures
        1. 12.3.1 Theoretical Limits to Leverage
        2. 12.3.2 Leverage Mechanics
        3. 12.3.3 Expected Returns and Risk
      4. 12.4 Stocks, Cash, and Single-Stock Futures
        1. 12.4.1 Theoretical Limits of Leverage
        2. 12.4.2 Leverage Mechanics
        3. 12.4.3 Expected Returns, Risk, and α Mojo
      5. 12.5 Stocks, Cash, Individual Stocks, and Single-Stock and Basket Swaps
        1. 12.5.1 Margining Individual Stocks
        2. 12.5.2 Single-Stock and Basket Swaps
      6. 12.6 Stocks, Cash, and Options
      7. 12.7 Rebalancing
        1. 12.7.1 Cash and Futures
        2. 12.7.2 Stocks, Cash, and Futures
      8. 12.8 Liquidity Buffering
      9. 12.9 Leveraged Short
      10. 12.10 Conclusion
    2. Appendix 12A: Fair Value Computations
    3. Appendix 12B: Derivation of Equations (12.19), (12.20), and (12.21)
    4. Appendix 12C: Tables of Futures Leverage Multipliers to Achieve Various Degrees of Leverage
    5. 13 Market Neutral
      1. 13.1 Introduction
      2. 13.2 Market-Neutral Construction
        1. 13.2.1 Security Selection
        2. 13.2.2 Dollar Neutrality
        3. 13.2.3 Beta Neutrality (a.k.a Risk-Factor Neutrality)
        4. 13.2.4 Market-Neutral Portfolio Out of a Long-Only Portfolio
      3. 13.3 Market Neutral’s Mojo
      4. 13.4 The Mechanics of Market Neutral
        1. 13.4.1 Margin and Shorting
        2. 13.4.2 The Margin and Market Neutral
        3. 13.4.3 Sources of the Return
      5. 13.5 The Benefits and Drawbacks of Market Neutral
      6. 13.6 Rebalancing
      7. 13.7 General Long-Short
        1. 13.7.1 Long-Short
        2. 13.7.2 Equitization
        3. 13.7.3 Portable α
        4. 13.7.4 Pair Trading
      8. 13.8 Conclusion
    6. 14 Bayesian α
      1. 14.1 Introduction
      2. 14.2 The Basics of Bayesian Theory
      3. 14.3 Bayesian α Mojo
      4. 14.4 Quantifying Qualitative Information
        1. 14.4.1 Quantifying a Stock Screen
        2. 14.4.2 Quantifying a Stock Ranking
        3. 14.4.3 Quantifying the Buy and Sell Recommendations
      5. 14.5 The Z-Score-Based Prior
      6. 14.6 Scenario-Based Priors
      7. 14.7 Posterior Computation
      8. 14.8 The Information Criterion and Bayesian α
      9. 14.9 Conclusion
  12. IV Performance Analysis
    1. 15 Performance Measurement and Attribution
      1. 15.1 Introduction
      2. 15.2 Measuring Returns
        1. 15.2.1 No Cash Flows
        2. 15.2.2 Inflows and Outflows
        3. 15.2.3 Measuring Returns for Market Neutral and Leveraged Portfolios
      3. 15.3 Measuring Risk
        1. 15.3.1 Standard Deviation
        2. 15.3.2 Semi-Standard Deviation
        3. 15.3.3 Tracking Error
        4. 15.3.4 CAPM β
        5. 15.3.5 Value-at-Risk
        6. 15.3.6 Covariance and Correlation
      4. 15.4 Risk-Adjusted Performance Measurement
        1. 15.4.1 The Sharpe Ratio
        2. 15.4.2 The Information Ratio
        3. 15.4.3 The CAPM α and the Benchmark α
        4. 15.4.4 The Multifactor α
        5. 15.4.5 Practical Issues with Risk-Adjusted Measures
      5. 15.5 Performance Attribution
        1. 15.5.1 Classical Attribution
        2. 15.5.2 Multifactor QEPM Attribution
      6. 15.6 Conclusion
    2. Appendix 15A: Style Analysis
      1. Appendix 15B: Measures of Opportunity
      2. Appendix 15C: Short Returns
      3. Appendix 15D: Measuring Market Timing Ability
  13. V Practical Application
    1. 16 The Backtesting Process
      1. 16.1 Introduction
      2. 16.2 The Data and Software
      3. 16.3 The Time Period
      4. 16.4 The Investment Universe and the Benchmark
        1. 16.4.1 U.S. Equity Benchmarks
        2. 16.4.2 A Comparison of the Major U.S. Equity Benchmarks
        3. 16.4.3 The Most Popular Benchmarks and Our Benchmarks
      5. 16.5 The Factors
      6. 16.6 The Stock-Return and Risk Models
      7. 16.7 Parameter Stability and the Rebalancing Frequency
      8. 16.8 Variations on the Baseline Portfolio
        1. 16.8.1 Transactions Costs
        2. 16.8.2 Taxes
        3. 16.8.3 Leverage
        4. 16.8.4 Market Neutral
      9. 16.9 Conclusion
    2. Appendix 16A: Factor Formulas
    3. 17 The Portfolios’ Performance
      1. 17.1 Introduction
      2. 17.2 The Performance of the Baseline Portfolios
        1. 17.2.1 The Fundamental Factor Model Performance
        2. 17.2.2 The Aggregate Z-Score Model Performance
        3. 17.2.3 The Economic Factor Model Performance
        4. 17.2.4 Performance Reports for Distribution
        5. 17.2.5 Performance Attribution for the Economic Factor Baseline Model
      3. 17.3 The Transactions Cost-Managed Portfolio Performance
      4. 17.4 The Tax-Managed Portfolio Performance
      5. 17.5 The Leveraged Portfolio Performance
      6. 17.6 The Market-Neutral Portfolio Performance
      7. 17.7 Conclusion
  14. Contents of the CD
  15. Glossary
  16. Bibliography
  17. Index
  18. Footnotes
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