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The Alpha and Beta of Risk Attribution

Ben Davis and Jose Menchero
The Journal of Portfolio Management Winter 2012, 38 (2) 99-107; DOI: https://doi.org/10.3905/jpm.2012.38.2.099
Ben Davis
is a vice president at MSCI in Berkeley, CA.
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  • For correspondence: benjamin.l.davis@msci.com
Jose Menchero
is an executive director at MSCI in Berkeley, CA.
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  • For correspondence: jose.menchero@msci.com
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Abstract

Davis and Menchero present a methodology for attributing the alpha and beta components of tracking error. They define an intuitive and precise decomposition of tracking error into alpha and beta components. Their approach is completely general and is applicable to security-, sector-, and factor-based investment processes. The authors show that by following this methodology, drilldowns into tracking error at any level of granularity can be neatly decomposed into parallel alpha and beta drilldowns. They also show that factor-based risk attribution represents an important special case of the alpha and beta risk decomposition, and they demonstrate that the residual exposure-based analysis of residual risk is prone to counterintuitive attribution effects.

TOPICS: Factor-based models, volatility measures, statistical methods

  • Copyright © 2012 MSCI. 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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The Alpha and Beta of Risk Attribution
Ben Davis, Jose Menchero
The Journal of Portfolio Management Jan 2012, 38 (2) 99-107; DOI: 10.3905/jpm.2012.38.2.099

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The Alpha and Beta of Risk Attribution
Ben Davis, Jose Menchero
The Journal of Portfolio Management Jan 2012, 38 (2) 99-107; DOI: 10.3905/jpm.2012.38.2.099
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  • Article
    • Abstract
    • THE ALPHA AND BETA DECOMPOSITION
    • EXAMPLE: TOP-LEVEL ATTRIBUTION
    • EXAMPLE: SECURITY-LEVEL ATTRIBUTION
    • EXAMPLE: SECTOR-BASED ATTRIBUTION
    • EXAMPLE: FACTOR-BASED ATTRIBUTION
    • EXAMPLE: RESIDUAL EXPOSURE APPROACH
    • CONCLUSION
    • APPENDIX
    • ENDNOTES
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