Factor Models for Alpha Streams

The Journal of Investment Strategies 4(1) (2014) 83-109

27 Pages Posted: 14 Jun 2014 Last revised: 16 Jan 2015

See all articles by Zura Kakushadze

Zura Kakushadze

Quantigic Solutions LLC; Free University of Tbilisi

Date Written: September 3, 2014

Abstract

We propose a framework for constructing factor models for alpha streams. Our motivation is threefold. 1) When the number of alphas is large, the sample covariance matrix is singular. 2) Its out-of-sample stability is challenging. 3) Optimization of investment allocation into alpha streams can be tractable for a factor model alpha covariance matrix. We discuss various risk factors for alphas such as: style risk factors; cluster risk factors based on alpha taxonomy; principal components; and also using the underlying tradables (stocks) as alpha risk factors, for which computing the factor loadings and factor covariance matrices does not involve any correlations with alphas, and their number is much larger than that of the relevant principal components. We draw insight from stock factor models, but also point out substantial differences.

Keywords: factor model, alpha stream, style factor, cluster, optimization, covariance matrix, factor loadings, specific risk, turnover, capacity, momentum, volatility

JEL Classification: G00

Suggested Citation

Kakushadze, Zura, Factor Models for Alpha Streams (September 3, 2014). The Journal of Investment Strategies 4(1) (2014) 83-109. Available at SSRN: https://ssrn.com/abstract=2449927 or http://dx.doi.org/10.2139/ssrn.2449927

Zura Kakushadze (Contact Author)

Quantigic Solutions LLC ( email )

1127 High Ridge Road #135
Stamford, CT 06905
United States
6462210440 (Phone)
6467923264 (Fax)

HOME PAGE: http://www.linkedin.com/in/zurakakushadze

Free University of Tbilisi ( email )

Business School and School of Physics
240, David Agmashenebeli Alley
Tbilisi, 0159
Georgia

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