Specific Risk and Replication of Factor Returns
12 Pages Posted: 6 Aug 2014
Date Written: August 8, 2014
Abstract
In this paper we try to improve the estimate of the specific covariance matrix in a fundamental multifactor model in order to make the risk model fully consistent. We propose a simple method to modify the diagonal specific covariance matrix in order to obtain consistency between the ex-ante and ex-post risk measurement for the so called factor mimicking portfolios. The method proposed modifies only slightly the overall risk measure but greatly facilitate the construction of portfolios with a fundamental factor tilt.
Keywords: Fundamental Factor Risk Model, Portfolio Optimization, Factor tilt
JEL Classification: c1, c6, g11
Suggested Citation: Suggested Citation