Fnce Case Study

Common Stock Investment Strategies

1) Factor-based trading strategies (stock selection or alpha models)

2) Statistical arbitrage

3) High-frequency strategies

4) Event studies

Factor, define as a common characteristic among a group of assets. E.g. Price earnings or book price ratio. Factor is also frequently intended to capture some economic intuition. (e.g., may help understand the price of assets by reference to their exposure to sources of macroeconomic risk, fundamental characteristic, or basic market behavior). Assets with similar factors (characteristics) tend to behave in similar ways. (Critical to success of a factor). Our factors should be able to differentiate across different markets and samples. Our factor to be robust across different time periods.

Factors fall into three categories:

* Macroeconomic influences

* Time series that measure observable economic activity

* E.g. GDP, interest rate levels, industrial production

* Cross-sectional characteristics

* Observable asset specifics or firm characteristics

* E.g. dividend yield, book value, volatility

* Statistical factors (latent factors)

* Not derived using exogenous data => extracted from other variables such as return.

* Calculated using various statistical techniques such as principal components analysis or factor analysis

Models:

* Central to managing portfolio => send model output to trading desk directly

* Provide analytical support to analysts and portfolio management teams => reduce investable universe to a manageable number of securities => a team of analysts can perfor.m fundamental analysis on a smaller group of securities

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Equity forecasting models: Alpha or stock selection models

* Mathematical representations of trading strategies

* Uses future returns as dependent variables and factors as independent variables

* Basic Framework

* Defining a trading idea or investment...