Custom v. Standardized Risk Models

Zura Kakushadze and Jim Kyung-Soo Liew
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Zura Kakushadze: Quantigic Solutions LLC, 1127 High Ridge Road #135, Stamford, CT 06905, USA
Jim Kyung-Soo Liew: The Johns Hopkins Carey Business School, 100 International Drive, Baltimore, MD 21202, USA

Risks, 2015, vol. 3, issue 2, 1-27

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; portfolio optimization (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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