Contextual Fundamentals, Models, and Active Management

44 Pages Posted: 16 Mar 2005

See all articles by Eric H. Sorensen

Eric H. Sorensen

PanAgora Asset Management

Ronald Hua

PanAgora Asset Management

Edward E. Qian

PanAgora Asset Management

Date Written: February 2005

Abstract

Applying a multifactor alpha model across a diverse range of stocks is a popular approach to forecast securities' expected returns. This approach assumes that one single return-generating equation provides adequate alpha forecasts - that is, one-size-fits-all. In this paper, we extend prior empirical research by introducing an alternative alpha-modeling approach. Our approach presents a parsimonious way of modeling securities individually in order to capture the idiosyncratic return behavior pertaining to different security contexts.

Our investment objective is information ratio maximization, through optimal alpha factor weights. Our modeling technique demonstrates the importance of different factor categories (cheapness, quality, and sentiment) that vary significantly across various security contexts. These contexts span typical dimensions of risk characteristics (value, growth, or earnings variability). We illustrate how practitioners can apply our technique in their security selection process, and document to what extent our approach improves the ex post information ratio when compared with a one-size-fits-all approach.

Keywords: active management, contextual analysis, and equity alpha model

JEL Classification: D40, G12

Suggested Citation

Sorensen, Eric H. and Hua, Ronald and Qian, Edward E., Contextual Fundamentals, Models, and Active Management (February 2005). Available at SSRN: https://ssrn.com/abstract=683904 or http://dx.doi.org/10.2139/ssrn.683904

Eric H. Sorensen (Contact Author)

PanAgora Asset Management ( email )

260 Franklin Street
Boston, MA 02110
United States

Ronald Hua

PanAgora Asset Management ( email )

260 Franklin Street
Boston, MA 02110
United States

Edward E. Qian

PanAgora Asset Management ( email )

470 Atlantic Avenue, 8th Floor
Boston, MA 02210
United States
617-439-6327 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
1,853
Abstract Views
5,593
rank
8,231
PlumX Metrics