Linear Factor Models: Theory, Applications and Pitfalls

51 Pages Posted: 21 Nov 2014 Last revised: 8 Dec 2014

See all articles by Attilio Meucci

Attilio Meucci

ARPM - Advanced Risk and Portfolio Management

Date Written: Decermber 7, 2014

Abstract

We clarify the rationale and differences between the two main categories of linear factor models, namely dominant-residual and systematic-idiosyncratic. We discuss the five different, yet interconnected areas of quantitative finance where linear factor models play an essential role: multivariate estimation theory, asset pricing theory, systematic strategies, portfolio optimization, and risk attribution. We present a comprehensive list of common pitfalls and misunderstandings on linear factor models. An appendix details all the calculations. Supporting code is available for download.

Keywords: generalized r-square, fundamental factor models, macroeconomic factor models, factor analysis, regression, random matrix theory, GICS industry classification, cross-sectional models, time-series models, statistical models

JEL Classification: C1, G11

Suggested Citation

Meucci, Attilio, Linear Factor Models: Theory, Applications and Pitfalls (Decermber 7, 2014). Available at SSRN: https://ssrn.com/abstract=1635495 or http://dx.doi.org/10.2139/ssrn.1635495

Attilio Meucci (Contact Author)

ARPM - Advanced Risk and Portfolio Management ( email )

HOME PAGE: http://www.arpm.co/

Register to save articles to
your library

Register

Paper statistics

Downloads
3,015
rank
3,516
Abstract Views
6,437
PlumX Metrics
!

Under construction: SSRN citations while be offline until July when we will launch a brand new and improved citations service, check here for more details.

For more information