Preface xiii
About the Editors xxiii
Contributing Authors xxv
Chapter 1 An Introduction to Quantitative Equity Investing 1
Paul Bukowski
Equity Investing 1
Fundamental vs. Quantitative Investor 2
The Quantitative Stock Selection Model 7
The Overall Quantitative Investment Process 9
Research 9
Portfolio Construction 18
Monitoring 21
Current Trends 22
Key Points 23
Questions 24
Chapter 2 Equity Analysis Using Traditional and Value-Based Metrics 25
James L. Grant and Frank J. Fabozzi
Overview of Traditional Metrics 25
Price Multiples 32
Fundamental Stock Return 36
Traditional Caveats 38
Overview of Value-Based Metrics 39
Key Points 58
Appendix: Case Study 60
Questions 69
Chapter 3 A Franchise Factor Approach to Modeling P/E Orbits 71
Stanley Kogelman and Martin L. Leibowitz
Background 72
Historical Data Observations 75
Formulation of the Basic Model 81
P/E Myopia: The Fallacy of a Stable P/E 85
Two-Phase P/E Orbits 91
Franchise Valuation under Q-Type Competition 96
Franchise Labor 97
Key Points 101
Questions 102
Chapter 4 Relative Valuation Methods for Equity Analysis 105
Glen A. Larsen Jr., Frank J. Fabozzi, and Chris Gowlland
Basic Principles of Relative Valuation 106
Hypothetical Example 115
Key Points 123
Questions 124
Chapter 5 Valuation over the Cycle and the Distribution of Returns 125
Anders Ersbak Bang Nielsen and Peter C. Oppenheimer
The Link Between Earnings and Returns 126
The Phases Can Be Interpreted in Relationship to the Economy 132
Asset Class Performance Varies across the Phases 137
Incorporating Cyclicality into Valuations 139
Appendix: Dates and Returns of the Phases 142
Key Points 146
Questions 146
Chapter 6 An Architecture for Equity Portfolio Management 147
Bruce I. Jacobs and Kenneth N. Levy
Architectural Building Blocks 148
Traditional Active Management 151
Passive Management 156
Engineered Management 157
Expanding Opportunities 160
The Risk-Return Continuum 163
The Ultimate Objective 167
Key Points 168
Questions 169
Chapter 7 Equity Analysis in a Complex Market 171
Bruce I. Jacobs and Kenneth N. Levy
An Integrated Approach to a Segmented Market 172
Disentangling 176
Constructing, Trading, and Evaluating Portfolios 184
Profiting from Complexity 186
Key Points 187
Questions 188
Chapter 8 Survey Studies of the Use of Quantitative Equity Management 189
Frank J. Fabozzi, Sergio M. Focardi, and Caroline L. Jonas
2003 Intertek European Study 189
2006 Intertek Study 197
2007 Intertek Study 205
Challenges for Quantitative Equity Investing 224
Modeling After the 20072009 Global Financial Crisis 226
Key Points 228
Questions 229
Chapter 9 Implementable Quantitative Equity Research 231
Frank J. Fabozzi, Sergio M. Focardi, and K. C. Ma
The Rise of Econophysics 233
A General Framework 235
Select a Sample Free from Survivorship Bias 238
Select a Methodology to Estimate the Model 239
Risk Control 246
Key Points 248
Questions 249
Chapter 10 Tracking Error and Common Stock Portfolio Management 251
Raman Vardharaj, Frank J. Fabozzi, and Frank J. Jones
Definition of Tracking Error 251
Components of Tracking Error 254
Forward-Looking vs. Backward-Looking Tracking Error 255
Information Ratio 256
Determinants of Tracking Error 257
Marginal Contribution to Tracking Error 261
Key Points 262
Questions 263
Chapter 11 Factor-Based Equity Portfolio Construction and Analysis 265
Petter N. Kolm, Joseph A. Cerniglia, and Frank J. Fabozzi
Factor-Based Trading 266
Developing Factor-Based Trading Strategies 269
Risk to Trading Strategies 271
Desirable Properties of Factors 273
Sources for Factors 273
Building Factors from Company Characteristics 274
Working with Data 275
Analysis of Factor Data 283
Key Points 287
Questions 289
Chapter 12 Cross-Sectional Factor-Based Models and Trading Strategies 291
Joseph A. Cerniglia, Petter N. Kolm, and Frank J. Fabozzi
Cross-Sectional Methods for Evaluation of Factor Premiums 292
Factor Models 300
Performance Evaluation of Factors 310
Model Construction Methodologies for a Factor-based Trading Strategy 317
Backtesting 328
Backtesting Our Factor Trading Strategy 330
Key Points 331
Appendix: The Compustat Point-in-Time, IBES Consensus Databases and Factor Definitions 333
Questions 337
Chapter 13 Multifactor Equity Risk Models and Their Applications 339
Anthony Lazanas, António Baldaque da Silva, Arne D. Staal, and Cenk Ural
Motivation 340
Equity Risk Factor Models 342
Applications of Equity Risk Models 350
Key Points 370
Questions 371
Chapter 14 Dynamic Factor Approaches to Equity Portfolio Management 373
Dorsey D. Farr
Methods of Active Management 376
Modeling 385
Implementation 392
Key Points 395
Questions 395
Chapter 15 A Factor Competition Approach to Stock Selection 397
Joseph Mezrich and Junbo Feng
The Problem 397
The Solution 403
Which Factors Get Picked? 407
Does the Alpha Repair Process Work? 408
Key Points 411
Questions 412
Chapter 16 Avoiding Unintended Country Bets in Global Equity Portfolios 413
Michele Aghassi, Cliff Asness, Oktay Kurbanov, and Lars N. Nielsen
Country Membership and Individual Stock Returns 414
Ways to Build Active Global Portfolios 416
Studying the Naive Portfolio 419
Empirical Results 420
Why Does the Naive Stock Selection Portfolio Make Country Noise Bets? 422
Key Points 423
Questions 424
Chapter 17 Modeling Market Impact Costs 425
Petter N. Kolm and Frank J. Fabozzi
Market Impact Costs 426
Liquidity and Transaction Costs 427
Market Impact Measurements and Empirical Findings 430
Forecasting and Modeling Market Impact 433
Key Points 439
Questions 440
Chapter 18 Equity Portfolio Selection in Practice 441
Dessislava A. Pachamanova and Frank J. Fabozzi
Portfolio Constraints Commonly Used in Practice 442
Benchmark Exposure and Tracking Error Minimization 450
Incorporating Transaction Costs 454
Incorporating Taxes 460
Multi-Account Optimization 465
Robust Parameter Estimation 469
Portfolio Resampling 471
Robust Portfolio Optimization 474
Key Points 480
Questions 481
Chapter 19 Portfolio Construction and Extreme Risk 483
Jennifer Bender, Jyh-Huei Lee, and Dan Stefek
Measures of Extreme Loss 484
Constraining Shortfall 485
Performance 485
Imposing Benchmark Neutrality 487
Analysis 489
Key Points 493
Appendix: Constructing Out-of-Sample Shortfall Betas 494
Questions 495
Chapter 20 Working with High-Frequency Data 497
Irene Aldridge
What is High-Frequency Data? 497
How is High-Frequency Data Recorded? 499
Properties of High-Frequency Data 500
High-Frequency Data are Voluminous 501
High-Frequency Data are Subject to Bid-Ask Bounce 503
High-Frequency Data are Irregularly Spaced in Time 509
Equity Correlations Decay at High Frequencies 517
Key Points 519
Questions 520
Chapter 21 Statistical Arbitrage 521
Brian J. Jacobsen
Pairs Trading 523
General Models 532
Key Points 534
Questions 534
About the Website 535
Index 537
