Quantitative Portfolio Management

Chapter 6Portfolio Construction

To trade a profitable portfolio, one generally wants to buy low and sell high. To systematically follow through on this, we need a forecast of future returns, a risk model, a trading cost model, and a portfolio construction algorithm using all of the above.

6.1 Hedged allocation

Ms. Three, Ms. Five, and Ms. Eight are making a cake. For this project Ms. Three contributes 3 lbs of flour, Ms. Five contributes 5 lbs of flour, and Ms. Eight, who has no flour, pays $8 cash. If the deal is fair, how much cash do Ms. Three and Ms. Five get back?

From a quant interview

Perhaps the simplest, and therefore fairly popular, portfolio construction method is signal-based allocation. A “signal” is either a forecast or a number proportional to, or altogether replacing, the forecast. Given signals , one computes portfolio positions proportional to . If there is only one risk factor to avoid, such as the market, one adds to the portfolio a hedge, a liquid ETF instrument such as SPY for US equities, as a market proxy with beta close to 1, in the amount computed to kill the market exposure of the portfolio. If there are industrial sector risk factors, they can be handled ...