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The Journal of Portfolio Management

The Journal of Portfolio Management

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Article

Factor Alignment Problems and Quantitative Portfolio Management

Sebastián Ceria, Anureet Saxena and Robert A. Stubbs
The Journal of Portfolio Management Winter 2012, 38 (2) 29-43; DOI: https://doi.org/10.3905/jpm.2012.38.2.029
Sebastián Ceria
is the chief executive officer of Axioma, Inc., in New York, NY.
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  • For correspondence: sceria@axioma.com
Anureet Saxena
is a senior associate in research at Axioma, Inc., in Atlanta, GA.
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  • For correspondence: asaxena@axioma.com
Robert A. Stubbs
is a vice president in research at Axioma, Inc., in Atlanta, GA.
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  • For correspondence: rstubbs@axioma.com
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Abstract

Quantitative equity portfolio management has evolved into an interdisciplinary activity that draws expertise from the fields of finance, statistics, econometrics, accounting, and optimization. Each one of these streams is a mature discipline in itself, having its own body of knowledge, and operates under assumptions that are usually well accepted within the respective communities. But when concepts from these diverse fields are applied in a common setting, there is bound to be friction among various assumptions that get further magnified due to the use of an optimizer. In this article, Ceria, Saxena, and Stubbs focus on the interaction of three key elements that are part of the quantitative portfolio management process, namely, the expected returns model, the risk model, and the constraints that are used to formulate the portfolio construction problem. They generally refer to the issues caused by this interaction as factor alignment problems. The authors present a detailed investigation of these alignment problems, survey some of their common sources, analyze and document their effects on the ex post performance of optimized portfolios, and conclude with a practical and effective remedy in the form of augmented risk models.

  • Copyright © 2012 Axioma, Inc. All rights reserved. Not to be reproduced or redistributed without permission.
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The Journal of Portfolio Management: 38 (2)
The Journal of Portfolio Management
Vol. 38, Issue 2
Winter 2012
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Factor Alignment Problems and Quantitative Portfolio Management
Sebastián Ceria, Anureet Saxena, Robert A. Stubbs
The Journal of Portfolio Management Jan 2012, 38 (2) 29-43; DOI: 10.3905/jpm.2012.38.2.029

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Factor Alignment Problems and Quantitative Portfolio Management
Sebastián Ceria, Anureet Saxena, Robert A. Stubbs
The Journal of Portfolio Management Jan 2012, 38 (2) 29-43; DOI: 10.3905/jpm.2012.38.2.029
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  • Article
    • Abstract
    • MISALIGNMENT PROBLEMS: SOURCES
    • MISALIGNMENT PROBLEMS: EFFECTS
    • MISALIGNMENT PROBLEMS: ANALYSIS
    • MISALIGNMENT PROBLEMS: SOLUTION
    • CASE STUDY
    • CUSTOM RISK MODELS
    • CONCLUSION
    • ENDNOTES
    • REFERENCES
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  • PDF (Subscribers Only)

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