Sunday, 4 September 2011

Financial Factor Modelling

Factor model is a fundamental model in finance. Theories like Modern Portfolio Theory and Arbitrage Pricing Theory are based on it. Underlying assumption is the return of the securities is a result of combination of number of factors. The factors are systemic and individual factors. Many of the systemic factors affect the individual factors and club themselves as a component affecting the return from securities. It is a way of decomposing the forces which influence a security’s rate of return. Factor model can also be extended to account for the macroeconomic factors affecting the securities. Statistical model is used to explain the risks specific to an investment. Fundamental factoring accounts the industry risks. Third, macroeconomic factors containing the risks relevant to the economy. Factor analysis works on the number of dependent variables and seeks to identify the independent variables affecting them. These independent variables called factors reduce the number of variables the analysts have to break their head over so as to make predictions about the direction of the investment.

These class room techniques have their implementation in the real life which actually giving insights not only into various dimensions which otherwise might have been overlooked but also into those intricacies which might also been overlooked purposely, leaving no room for escaping.

Sakshi Goel


Finance Group-1

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