Beta is the color of an angel’s eye.
Tenet 4 of quantitative equity portfolio management (QEPM) requires quantitative analysis to efficiently combine all the information relevant to an investment decision. In Chapter 6, we looked at the fundamental factor model as one efficient way to combine relevant information about stocks into a system for determining returns and risks. The economic factor model is the counterpart to the fundamental factor model. It also combines relevant stock information in an efficient way, but with a different twist on the factor model framework.1
The structure of the model remains the same as we move from the fundamental factor model to the economic factor ...