Factors on Demand: Building a Platform for Portfolio Managers, Risk Managers and Traders
Risk, Vol. 23, No.7, p. 84-89

    Published On 01/03/2011
    Author Name : 
    Attilio Meucci
    Published Date: 
    Monday, Mar 8, 2010
    Last Update: 
    Monday, Oct 11, 2010

    We introduce "Factors on Demand", a modular, multi-asset-class return decomposition framework that extends beyond the standard systematic-plus-idiosyncratic approach. This framework, which rests on the conditional link between flexible bottom-up estimation factor models and flexible top-down attribution factor models, attains higher explanatory power, empirical accuracy and theoretical consistency than standard approaches. We explore applications stemming from factors on demand: - The joint use of a statistical model with non-idiosyncratic residual for return estimation and a cross-sectional model for return attribution - The optimal hedge of a portfolio of options, even when the investment horizon is close to the expiry and thus the securities are heavily non-linear - The "on demand" feature of FoD to extract a parsimonious set of few dominant attribution factors/hedges that change dynamically with time - Accommodating in the same platform global and regional models that give rise to the same, consistent risk numbers - Point-in-time style analysis, as opposed to the standard trailing regression - Risk attribution to select target portfolios to track the effect of incremental alpha signals on the allocation process