Tools for Describing Risk Factors and Portfolios

Nigel Da Costa Lewis

Vast amounts of data are available on all aspects of the financial markets and economy. However, raw data alone is not information! To compete successfully you must be able to extract useful insights from your data and use them to better manage risk and thereby enhance long-run returns. To extract information you must carefully and correctly analyse, present and interpret your data. Descriptive statistics is usually the first step in this process. This describes a broad range of methods used to summarise the essential characteristics of a sample of data. In this chapter, we will introduce a number of the core metrics used by statisticians. In describing risk factors and portfolios, they are primarily focused on central tendency, spread and shape.

CALCULATING RISK FACTOR RETURNS

Before the descriptive analysis of risk factors can begin, we need to ensure our data is in an appropriate format. For the most part, data are converted into rates of returns, which provide a measure of the size of an investment opportunity. There are two types of return often used in the statistical analysis of risk factor data. The first is the simple return; second is the log return. For time period t