CH3 : Basic QEPM Models

3.2 Basic QEPM models and portfolio construction procedures

There are two generic factor models that are used to determine how stock returns and risks vary with factors

• Fundamental factor model
• Economic factor model

They employ different techniques for modeling stock returns.

Average stock return is determined by the product of the factor premium and the factor exposure.

• Factor premium : How much investors are willing to pay for each factor 
• Fundamental factor model : Must be estimated with historical relationships between stock returns and factor exposure
• Economic factor medel : Can be determined up to a propotionality without a statical estimation in certain cases
• Factor exposure : measures how sensitive the stock return is to a factor
• Fundamental factor model (ex> p/e, marketcap..) : directly observerable 
• Economic factor model  : Must be estimeated

<Steps>

3.2.1 Factor Choice

3.2.2 The data decision

• Cross-sectional dimension : The cross-sectional dimension defines a data set by the characteristics of the stocks it includes 
• 특정 data set 의 특징은  최종 포트폴리오에 영향을 미칠 것이다.
• 특정 data set 에 속한 주식의 숫자는 estimation을 쉽게 만들 것이다.
• Time-series dimension : 

3.2.3 Factor Exposure

• Fundamental factor model : easy
• Economic factor model : 뒤에서 이야기 하겠지만 먼저 factor premium을 계산하고, 이 factor premium과 return과의 관계를 통해서 계산한다.

3.2.4 Factor Premium