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Custom v. Standardized Risk Models

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Quantigic Solutions LLC, 1127 High Ridge Road #135, Stamford, CT 06905, USA
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Business School & School of Physics, Free University of Tbilisi, 240, David Agmashenebeli Alley, Tbilisi 0159, Georgia
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The Johns Hopkins Carey Business School, 100 International Drive, Baltimore, MD 21202, USA
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Author to whom correspondence should be addressed.
Academic Editor: Andrea Consiglio
Risks 2015, 3(2), 112-138; https://doi.org/10.3390/risks3020112
Received: 19 February 2015 / Accepted: 15 May 2015 / Published: 20 May 2015
(This article belongs to the Special Issue Financial Engineering to Address Complexity)
We discuss when and why custom multi-factor risk models are warranted and give source code for computing some risk factors. Pension/mutual funds do not require customization but standardization. However, using standardized risk models in quant trading with much shorter holding horizons is suboptimal: (1) longer horizon risk factors (value, growth, etc.) increase noise trades and trading costs; (2) arbitrary risk factors can neutralize alpha; (3) “standardized” industries are artificial and insufficiently granular; (4) normalization of style risk factors is lost for the trading universe; (5) diversifying risk models lowers P&L correlations, reduces turnover and market impact, and increases capacity. We discuss various aspects of custom risk model building. View Full-Text
Keywords: risk model; multi-factor; risk factor; short horizon; quant trading; style; industry; specific risk; factor risk; portfolio optimization risk model; multi-factor; risk factor; short horizon; quant trading; style; industry; specific risk; factor risk; portfolio optimization
MDPI and ACS Style

Kakushadze, Z.; Liew, J.K.-S. Custom v. Standardized Risk Models. Risks 2015, 3, 112-138.

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