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Quantitative Equity Portfolio Management An Active Approach to Portfolio Construction and Management

by: Chincarini, Ludwig; Kim, Daehwan

Quantitative Equity Portfolio Management An Active Approach to Portfolio Construction and Management

by: Chincarini, Ludwig; Kim, Daehwan

ISBN 13:
9780071459396
ISBN 10:
0071459391
Edition: 1st
Format: Package
Copyright: 08/17/2006
Publisher: McGraw Hill
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Summary

"Quantitative Equity Portfolio Management is a comprehensive guide to the entire process of constructing and managing a high-yield quantitative equity portfolio. This detailed handbook begins with the basic principles of quantitative active management and then clearly outlines how to build an equity portfolio using those powerful concepts."--BOOK JACKET.

Foreword

Preface

xvii

Notations and Abbreviations

xxi

I An Overview of QEPM

(88)

1 The Power of QEPM

(18)

1.1 Introduction

(4)

1.2 The Advantages of QEPM

(5)

1.3 Quantitative and Qualitative Approaches to Similar Investment Situations

(5)

1.4 A Tour of the Book

(2)

1.5 Conclusion

(2)

2 The Fundamentals of QEPM

(44)

2.1 Introduction

(1)

2.2 QEPM a

(5)

2.2.1 Benchmark α

(1)

2.2.2 CAPM α

(1)

2.2.3 Multifactor α

(1)

2.2.4 A Variety of α's

(2)

2.2.5 Ex-Ante and Ex-Post α

(1)

2.2.6 Ex-Ante and Ex-Post Information Ratio

(1)

2.3 The Seven Tenets of QEPM

(2)

2.4 Tenets 1 and 2: Market Efficiency and QEPM

(19)

2.4.1 The Efficient-Market Hypothesis

(4)

2.4.2 Anomalies

(9)

2.4.3 Market Efficiency and QEPM

(6)

2.5 Tenets 3 and 4: The Fundamental Law, The Information Criterion, and QEPM

(4)

2.5.1 The Truth about the Fundamental Law

(2)

2.5.2 The Information Criterion

(1)

2.5.3 Information Loss

(1)

2.6 Tenets 5, 6, and 7: Statistical Issues in QEPM

(6)

2.6.1 Data Mining

(4)

2.6.2 Parameter Stability

(1)

2.6.3 Parameter Uncertainty

(1)

2.7 Conclusion

(7)

3 Basic QEPM Models

(24)

3.1 Introduction

(1)

3.2 Basic QEPM Models and Portfolio Construction Procedures

(7)

3.2.1 Factor Choice

(1)

3.2.2 The Data Decision

(1)

3.2.3 Factor Exposure

(1)

3.2.4 Factor Premium

(1)

3.2.5 Expected Return

(1)

3.2.6 Risk

(1)

3.2.7 Forecasting

(1)

3.2.8 Security Weighting

(1)

3.3 The Equivalence of the Basic Models

(2)

3.4 The Screening and Ranking of Stocks with the Z-Score

(1)

3.5 Hybrids of the Models and the Information Criterion

(6)

3.5.1 The Setup

(1)

3.5.2 The Z-Score Model

(1)

3.5.3 A Hybrid of the Z-Score Model and Fundamental Factor Model

(1)

3.5.4 Information Loss

(2)

3.6 Choosing the Right Model

(3)

3.6.1 Consistency with Economic Theory

(1)

3.6.2 Ability to Combine Different Types of Factors

(1)

3.6.3 Ease of Implementation

(1)

3.6.4 Data Requirement

(1)

3.6.5 Intuitive Appeal

(1)

3.7 Conclusion

(5)

II Portfolio Construction and Maintenance

(258)

4. Factors and Factor Choice

(44)

4.1 Introduction

(1)

4.2 Fundamental Factors

(14)

4.2.1 Valuation Factors

(5)

4.2.2 Solvency Factors

(2)

4.2.3 Operating Efficiency Factors

(1)

4.2.4 Operating Profitability Factors

100

(3)

4.2.5 Financial Risk Factors

103

(1)

4.2.6 Liquidity Factors

104

(2)

4.3 Technical Factors

106

(1)

4.4 Economic Factors

107

(1)

4.5 Alternative Factors

108

(3)

4.5.1 Analyst Factors

108

(2)

4.5.2 Corporate Finance Policy Factors

110

(1)

4.5.3 Social Responsibility Factors

110

(1)

4.6 Factor Choice

111

(7)

4.6.1 Univariate Regression Tests

112

(1)

4.6.2 Multiple Regression Tests

113

(1)

4.6.3 Unidimensional Zero-Investment Portfolio

114

(2)

4.6.4 Multidimensional Zero-Investment Portfolio

116

(1)

4.6.5 Techniques to Reduce the Number of Factors

116

(2)

4.7 Conclusion

118

(1)

Appendix 4A: Factor Definition Tables

119

(16)

5. Stock Screening and Ranking

135

(50)

5.1 Introduction

135

(1)

5.2 Sequential Stock Screening

136

(1)

5.3 Sequential Screens Based on Famous Strategies

137

(8)

5.4 Simultaneous Screening and the Aggregate Z-Score

145

(13)

5.4.1 The Z-Score

147

(2)

5.4.2 The Aggregate Z-Score

149

(1)

5.4.3 Ad Hoc Aggregate Z-Score

150

(1)

5.4.4 Optimal Aggregate Z-Score

150

(4)

5.4.5 Factor Groups and the Aggregate Z-Score

154

(4)

5.5 The Aggregate Z-Score and Expected Return

158

(5)

5.5.1 Expected Return Implied by the Z-Score

158

(3)

5.5.2 The Forecasting Rule of Thumb

161

(1)

5.5.3 The Equivalence between the Z-Score Model and the Fundamental Factor Model

162

(1)

5.6 The Aggregate Z-Score and the Multifactor a

163

(1)

5.7 Conclusion

164

(2)

Appendix 5A: A List of Stock Screens Based on Well-Known Strategies

166

(13)

Appendix 5B: On Outliers

179

(6)

6. Fundamental Factor Models

185

(26)

6.1 Introduction

185

(3)

6.2 Preliminary Work

188

(6)

6.2.1 Choosing Factors

189

(1)

6.2.2 Treatment of the Risk-Free Rate

189

(1)

6.2.3 Choosing the Time Interval and Time Period

190

(2)

6.2.4 Choosing the Universe of Stocks

192

(2)

6.3 Benchmark and a 193 6.4 Factor Exposure

194

(2)

6.5 The Factor Premium

196

(6)

6.5.1 OLS Estimator of the Factor Premium

197

(2)

6.5.2 Robustness Check

199

(1)

6.5.3 Outliers and MAD Estimator of Factor Premium

200

(1)

6.5.4 Heteroscedasticity and GLS Estimator of the Factor Premium

201

(1)

6.6 Decomposition of Risk

202

(3)

6.7 Conclusion

205

(6)

7 Economic Factor Models

211

(24)

7.1 Introduction

211

(3)

7.2 Preliminary Work

214

(2)

7.3 Benchmark and α

216

(1)

7.4 The Factor Premium

217

(6)

7.4.1 Factor Premium for Economic/Behavioral/ Market Factors

218

(1)

7.4.2 Factor Premium for Fundamental/Technical/ Analyst Factors

219

(3)

7.4.3 Factor Premium for Statistical Factors

222

(1)

7.5 Factor Exposure

223

(3)

7.5.1 The Standard Approach

223

(2)

7.5.2 When the Standard Approach Fails

225

(1)

7.6 Decomposition of Risk

226

(3)

7.6.1 The Standard Approach

226

(2)

7.6.2 When the Standard Approach Fails

228

(1)

7.7 Conclusion

229

(6)

8 Forecasting Factor Premiums and Exposures

235

(18)

8.1 Introduction

235

(1)

8.2 When Is Forecasting Necessary?

236

(1)

8.3 Combining External Forecasts

237

(1)

8.4 Model-Based Forecast

238

(1)

8.5 Econometric Forecast

239

(3)

8.6 Parameter Uncertainty

242

(2)

8.7 Forecasting the Stock Return

244

(2)

8.8 Conclusion

246

(7)

9 Portfolio Weights

253

(46)

9.1 Introduction

253

(2)

9.2 Ad Hoc Methods

255

(1)

9.3 Standard Mean-Variance Optimization

256

(12)

9.3.1 No Constraints

258

(4)

9.3.2 Short-Sale and Diversification Constraints

262

(4)

9.3.3 Sector or Industry Constraints

266

(1)

9.3.4 Trading-Volume Constraint

266

(1)

9.3.5 Risk-Adjusted Return

267

(1)

9.4 Benchmark

268

(1)

9.5 Ad Hoc Methods Again

268

(3)

9.6 Stratification

271

(2)

9.7 Factor-Exposure Targeting

273

(3)

9.8 Tracking-Error Minimization

276

(6)

9.8.1 Direct Computation

276

(2)

9.8.2 Tracking by Factor Exposure

278

(2)

9.8.3 Ghost Benchmark Tracking

280

(1)

9.8.4 Risk-Adjusted Tracking Error

281

(1)

9.9 Conclusion

282

(2)

Appendix 9A: Quadratic Programming

284

(15)

9A.1 Quadratic Programming with Equality Constraints

285

(2)

9A.2 A Numerical Example

287

(2)

9A.3 Quadratic Programming with Inequality Constraints

289

(4)

9A.4 A Numerical Example

293

(6)

10 Rebalancing and Transactions Costs

299

(24)

10.1 Introduction

299

(2)

10.2 The Rebalancing Decision

301

(2)

10.2.1 Rebalancing and Model Periodicity

301

(1)

10.2.2 Change in α and Other Parameters

302

(1)

10.3 Understanding Transactions Costs

303

(1)

10.4 Modeling Transactions Costs

304

(2)

10.5 Portfolio Construction with Transactions Costs

306

(3)

10.5.1 The Optimal Portfolio with Transactions Costs

306

(2)

10.5.2 The Tracking Portfolio with Transactions Costs

308

(1)

10.6 Dealing with Cash Flows

309

(8)

10.6.1 Reducing Transactions Cost Using Futures and ETFs

309

(1)

10.6.2 Rebalancing toward Optimal Target Weights

310

(7)

10.7 Conclusion

317

(1)

Appendix 10A: Approximate Solution to the Optimal Portfolio Problem

318

(5)

11 Tax Management

323

(24)

11.1 Introduction

323

(1)

11.2 Dividends, Capital Gains, and Capital Losses

324

(3)

11.3 Principles of Tax Management

327

(2)

11.4 Dividend Management

329

(3)

11.5 Tax-Lot Management

332

(2)

11.6 Tax-Lot Mathematics

334

(1)

11.7 Capital Gain and Loss Management

335

(3)

11.8 Loss Harvesting

338

(3)

11.8.1 Loss Harvesting and Reoptimizing

338

(2)

11.8.2 Loss Harvesting and Characteristic Matching

340

(1)

11.8.3 Loss Harvesting with a Benchmark

341

(1)

11.9 Gains from Tax Management

341

(2)

11.10 Conclusion

343

(4)

III α Mojo

347

(110)

12 Leverage

349

(50)

12.1 Introduction

349

(2)

12.2 Cash and Index Futures

351

(6)

12.2.1 Theoretical Bounds of Leverage

353

(1)

12.2.2 Leverage Mechanics

354

(2)

12.2.3 Expected Return and Risk

356

(1)

12.3 Stocks, Cash, and Index Futures

357

(5)

12.3.1 Theoretical Limits to Leverage

359

(1)

12.3.2 Leverage Mechanics

359

(1)

12.3.3 Expected Returns and Risk

360

(2)

12.4 Stocks, Cash, and Single-Stock Futures

362

(8)

12.4.1 Theoretical Limits of Leverage

363

(1)

12.4.2 Leverage Mechanics

364

(3)

12.4.3 Expected Returns, Risk, and α Mojo

367

(3)

12.5 Stocks, Cash, Individual Stocks, and Single-Stock and Basket Swaps

370

(3)

12.5.1 Margining Individual Stocks

371

(1)

12.5.2 Single-Stock and Basket Swaps

371

(2)

12.6 Stocks, Cash, and Options

373

(3)

12.7 Rebalancing

376

(4)

12.7.1 Cash and Futures

376

(3)

12.7.2 Stocks, Cash, and Futures

379

(1)

12.8 Liquidity Buffering

380

(4)

12.9 Leveraged Short

384

(1)

12.10 Conclusion

385

(2)

Appendix 12A: Fair Value Computations

387

(2)

Appendix 12B: Derivation of Equations (12.19), (12.20), and (12.21)

389

(2)

Appendix 12C: Tables of Futures Leverage Multipliers to Achieve Various Degrees of Leverage

391

(8)

13 Market Neutral

399

(36)

13.1 Introduction

399

(2)

13.2 Market-Neutral Construction

401

(5)

13.2.1 Security Selection

401

(1)

13.2.2 Dollar Neutrality

402

(1)

13.2.3 Beta Neutrality (a.k.a Risk-Factor Neutrality)

403

(3)

13.2.4 Market-Neutral Portfolio Out of a Long-Only Portfolio

406

(1)

13.3 Market Neutral's Mojo

406

(3)

13.4 The Mechanics of Market Neutral

409

(5)

13.4.1 Margin and Shorting

409

(2)

13.4.2 The Margin and Market Neutral

411

(1)

13.4.3 Sources of the Return

412

(2)

13.5 The Benefits and Drawbacks of Market Neutral

414

(5)

13.6 Rebalancing

419

(1)

13.7 General Long-Short

420

(8)

13.7.1 Long-Short

420

(1)

13.7.2 Equitization

421

(1)

13.7.3 Portable α

422

(2)

13.7.4 Pair Trading

424

(4)

13.8 Conclusion

428

(7)

14 Bayesian α

435

(22)

14.1 Introduction

435

(1)

14.2 The Basics of Bayesian Theory

436

(3)

14.3 Bayesiana α Mojo

439

(1)

14.4 Quantifying Qualitative Information

440

(4)

14.4.1 Quantifying a Stock Screen

440

(2)

14.4.2 Quantifying a Stock Ranking

442

(1)

14.4.3 Quantifying the Buy and Sell Recommendations

443

(1)

14.5 The Z-Score-Based Prior

444

(1)

14.6 Scenario-Based Priors

445

(3)

14.7 Posterior Computation

448

(2)

14.8 The Information Criterion and Bayesian α

450

(1)

14.9 Conclusion

451

(6)

IV Performance Analysis

457

(62)

15 Performance Measurement and Attribution

459

(60)

15.1 Introduction

459

(2)

15.2 Measuring Returns

461

(9)

15.2.1 No Cash Flows

462

(3)

15.2.2 Inflows and Outflows

465

(3)

15.2.3 Measuring Returns for Market Neutral and Leveraged Portfolios

468

(2)

15.3 Measuring Risk

470

(7)

15.3.1 Standard Deviation

471

(1)

15.3.2 Semi-Standard Deviation

472

(1)

15.3.3 Tracking Error

473

(1)

15.3.4 CAPM β

474

(2)

15.3.5 Value-at-Risk

476

(1)

15.3.6 Covariance and Correlation

477

(1)

15.4 Risk-Adjusted Performance Measurement

477

(11)

15.4.1 The Sharpe Ratio

479

(1)

15.4.2 The Information Ratio

480

(1)

15.4.3 The CAPM α and the Benchmark α

481

(1)

15.4.4 The Multifactor α

482

(3)

15.4.5 Practical Issues with Risk-Adjusted Measures

485

(3)

15.5 Performance Attribution

488

(8)

15.5.1 Classical Attribution

488

(3)

15.5.2 Multifactor QEPM Attribution

491

(5)

15.6 Conclusion

496

(1)

Appendix 15A: Style Analysis

497

(6)

Appendix 15B: Measures of Opportunity

503

(4)

Appendix 15C: Short Returns

507

(2)

Appendix 15D: Measuring Market Timing Ability

509

(10)

V Practical Application

519

(90)

16 The Backtesting Process

521

(60)

16.1 Introduction

521

(1)

16.2 The Data and Software

522

(3)

16.3 The Time Period

525

(6)

16.4 The Investment Universe and the Benchmark

531

(11)

16.4.1 U.S. Equity Benchmarks

532

(3)

16.4.2 A Comparison of the Major U.S. Equity Benchmarks

535

(2)

16.4.3 The Most Popular Benchmarks and Our Benchmarks

537

(5)

16.5 The Factors

542

(12)

16.6 The Stock-Return and Risk Models

554

(2)

16.7 Parameter Stability and the Rebalancing Frequency

556

(3)

16.8 Variations on the Baseline Portfolio

559

(7)

16.8.1 Transactions Costs

560

(2)

16.8.2 Taxes

562

(2)

16.8.3 Leverage

564

(1)

16.8.4 Market Neutral

565

(1)

16.9 Conclusion

566

(1)

Appendix 16A: Factor Formulas

567

(14)

17 The Portfolios'Performance

581

(28)

17.1 Introduction

581

(1)

17.2 The Performance of the Baseline Portfolios

582

(14)

17.2.1 The Fundamental Factor Model Performance

582

(3)

17.2.2 The Aggregate Z-Score Model Performance

585

(1)

17.2.3 The Economic Factor Model Performance

586

(2)

17.2.4 Performance Reports for Distribution

588

(2)

17.2.5 Performance Attribution for the Economic Factor Baseline Model

590

(6)

17.3 The Transactions Cost–Managed Portfolio Performance

596

(1)

17.4 The Tax-Managed Portfolio Performance

596

(3)

17.5 The Leveraged Portfolio Performance

599

(1)

17.6 The Market-Neutral Portfolio Performance

600

(3)

17.7 Conclusion

603

(6)

Contents of the CD

609

(2)

Glossary

611

(8)

Bibliography

619

(18)

Index

637

Amazon no longer offers textbook rentals. We do!

Quantitative Equity Portfolio Management An Active Approach to Portfolio Construction and Management

Quantitative Equity Portfolio Management An Active Approach to Portfolio Construction and Management

9780071459396

0071459391

Summary

Author Biography

Table of Contents

Supplemental Materials

Write a Review

Amazon no longer offers textbook rentals. We do!

Quantitative Equity Portfolio Management An Active Approach to Portfolio Construction and Management

Quantitative Equity Portfolio Management An Active Approach to Portfolio Construction and Management

9780071459396

0071459391

Summary

Author Biography

Table of Contents

Supplemental Materials

Write a Review

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