Custom v. Standardized Risk Models

Zura Kakushadze and Jim Kyung-Soo Liew

Papers from arXiv.org

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.

Date: 2014-09, Revised 2015-05
New Economics Papers: this item is included in nep-ger and nep-rmg
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Published in Risks 3(2) (2015) 112-138

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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1409.2575

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