Journal of Investment Strategies

Risk.net

Multifactor risk models and heterotic CAPM

Zura Kakushadze

  • A complete algorithm and source code for building general multifactor risk models.
  • Any combination of style factors, principal components and/or industry factors. 
  • This generalizes the heterotic risk model construction to include arbitrary factors. 
  • The presentation is intended to be essentially self-contained and pedagogical. 

ABSTRACT

We give a complete algorithm and source code for constructing general multifactor risk models (for equities) via any combination of style factors, principal components (betas) and/or industry factors. For short horizons, we employ the Russian-doll risk model construction to obtain a nonsingular factor covariance matrix. This generalizes the heterotic risk model construction to include arbitrary non-industry risk factors as well as industry risk factors with generic "weights". The aim of sharing our proprietary know-how with the investment community is to encourage organic risk model building. The paper is intended to be essentially self-contained and pedagogical.

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