ABSTRACT
Mean-variance optimization and risk models described in Chapter 2 and Chapter 3 provide the theoretical foundation of quantitative equity portfolio management. In Part II of the book, we dig deeper into the key ingredients of the Modern Portfolio eory (MPT) paradigm. An important component of any successful investment strategy is forecasting expected returns using alpha models. In this chapter, we consider the process of selecting or evaluating return factors that go into a comprehensive alpha model. In Chapter 5, we consider the typical set of quantitative alpha factors used in practice and their performance. In Chapter 6, we consider the rm valuation approach used in fundamental analysis and retool it for quantitative use. Chapter 7 presents the analytical framework for combining specic return factors into a comprehensive multiple-factor model designed to lead to consistent long-term performance. e essence is to create an expected return/covariance approach to “factor diversication,” analogous to classical stock selection methods discussed in Chapter 2. One additional dimension of factor evaluation is its associated portfolio turnover implication. We discuss this important topic in Chapter 8.
