Custom v. Standardized Risk Models

Risks 3(2) (2015) 112-138

30 Pages Posted: 9 Sep 2014 Last revised: 21 May 2015

See all articles by Zura Kakushadze

Zura Kakushadze

Quantigic Solutions LLC; Free University of Tbilisi

Jim Kyung-Soo Liew

Johns Hopkins University - Carey Business School

Date Written: May 7, 2015

Abstract

We discuss when and why custom multi-factor risk models are warranted and give source code for computing some risk factors. Pension/mutual funds do not require customization but standardization. However, using standardized risk models in quant trading with much shorter holding horizons is suboptimal: 1) longer horizon risk factors (value, growth, etc.) increase noise trades and trading costs; 2) arbitrary risk factors can neutralize alpha; 3) "standardized" industries are artificial and insufficiently granular; 4) normalization of style risk factors is lost for the trading universe; 5) diversifying risk models lowers P&L correlations, reduces turnover and market impact, and increases capacity. We discuss various aspects of custom risk model building.

Keywords: Risk model, multi-factor, risk factor, short horizon, quant trading, style, industry, specific risk, factor risk, alpha, portfolio optimization, regression

JEL Classification: G00

Suggested Citation

Kakushadze, Zura and Liew, Jim Kyung-Soo, Custom v. Standardized Risk Models (May 7, 2015). Risks 3(2) (2015) 112-138. Available at SSRN: https://ssrn.com/abstract=2493379 or http://dx.doi.org/10.2139/ssrn.2493379

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

Jim Kyung-Soo Liew

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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