Higher Order Comoments of Multifactor Models and Asset Allocation

Abstract

Accurate estimates of the higher order comoments are needed in asset allocation. We derive explicit formulas for the higher order comoments under the assumption that stock returns are generated by a multifactor model and show that this assumption leads to a substantial reduction in the number of parameters to estimate compared to the traditional approach. An out-of-sample analysis of the performance of portfolio allocation criteria that depend on the higher order comoments illustrates the usefulness of the proposed methodology.

Keywords: factor models, higher order comoments, portfolio selection

JEL Classification: G110, C580