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Dynamic Factor WeightsDynamic Factor Weights
Red Devil PartnersJoon Seong Choi, Youngjun Yoo, Richard Park, YK Kim
Overview
• Our purpose is to develop a stock selection strategy in order to outperform S&P 500.
• Our analysis includes both fixed and dynamic factor weights.
Source Data* Universe
* Universe Formula SP_500
* Benchmark Same as Universe
* Time Series
* Start Date 01/01/2000
* End Date 12/31/2005
* Calendar US COMPOSITE
* Universe 1 - Month
* Main Returns 1 - Month
* Factors 1 - Month
* Weights 1 - Month
* Return Sources
* Universe Return Sources Compustat;
* Benchmark Return Sources
Compustat;
* Risk Free Rate Return Sources
US - Disc. Rate 91D T-bill;
* Include Dividends Yes
* Currency U.S. Dollar
Steps
1) Specify list of factors
2) Univariate screens
3) Identify 5 fractiles for each factor
4) Choose significant portfolios
5) Optimize weights for portfolios with S&P500 volatility
6) Compare fixed weight strategy and dynamic weight strategy
-5
0
5
10
15
20
25
30
Cash to P D/E LTGrowth
Est.
Mcap NI 3yrGrowth
P to Book PriceMom
ROE Sales Rev Reinvest
1st 5th
Factor Returns
Identified factors
Factors (1m lagged)
- Cashflow to Price
- Debt to Equity
- Market Capitalization
- Price to Book
Factor Screen
- 0.03
- 0.02
- 0.01
0
0.01
0.02
0.03
0.04
- 1- - 2- - 3- - 4- - 5-
- 0.03
- 0.02
- 0.01
0
0.01
0.02
0.03
0.04
0.05
0.06
- 1- - 2- - 3- - 4- - 5-
- 0.05
0
0.05
0.1
0.15
0.2
0.25
0.3
0.35
- 1- - 2- - 3- - 4- - 5-
Cashflow to Price(5) : value weighted Debt to Equity(5) : value weighted
0
0.05
0.1
0.15
0.2
0.25
0.3
- 1- - 2- - 3- - 4- - 5-
Market Cap(1) : equal weighted Price to Book(5) : equal weighted
Optimization: fixed weights
• Form a portfolio with same volatility of S&P500
Return StdCashtoP(5) -0.20% 5.24%DtoE(5) -0.20% 6.87%MKTCap(1) -0.01% 4.36%MKTCap(5) 2.26% 6.4%PBK(5) 2.07% 6.3%SP500 0.0011% 4.39%
Correlation Matrix
Variable CTP_5 DTE_5 MCAP_1 MCAP_5 PBK_5 SP_500
CTP_5 1.000
DTE_5 0.831 1.000
MCAP_1 0.953 0.863 1.000
MCAP_5 0.832 0.618 0.815 1.000
PBK_5 0.797 0.530 0.788 0.954 1.000
SP_500 -0.029 0.097 -0.013 -0.092 -0.158 1.000
Weights CTP_5 DTE_5 MCAP_1 MCAP_5 PBK_5 SP_500 SUM-1.3866208 -0.352199 2.313 0.561965 -0.136616 1
Portfolio Return 1.32%Std 4.39%
Dynamic weight strategy
Add dummy variables3 months S&P500 momentumIn negative momentum, buy more portfolio with negative correlation with S&P500 (Price to book (5))
Optimization: dynamic weights
• Form a dynamic portfolio with same volatility of S&P500
Return StdCTP_5 -0.20% 5.24%DTE_5 -0.20% 6.87%
MCAP_1 -0.01% 4.36%MCAP_5 2.26% 6.44%
PBK_5 2.26% 6.27%PBK_5__Dummy 1.3820% 5.63% SP500 std 4.40%
Correlation Matrix
Variable CTP_5 DTE_5 MCAP_1 MCAP_5 PBK_5 PBK_5__Dummy
CTP_5 1.000
DTE_5 0.830 1.000
MCAP_1 0.953 0.862 1.000
MCAP_5 0.831 0.618 0.814 1.000
PBK_5 0.796 0.531 0.787 0.954 1.000
PBK_5__Dummy 0.731 0.564 0.703 0.831 0.870 1.000
Weights CTP_5 DTE_5 MCAP_1 MCAP_5 PBK_5 PBK_5__DummySUM-1.5513984 -0.327491 2.17962 0.509 -0.248882 0.439625 1
Portfolio Return 1.56%Std 4.40%
Results
0
50
100
150
200
250
300
350
1-01-2000 7-01-2000 1-01-2001 7-01-2001 1-01-2002 7-01-2002 1-01-2003 7-01-2003 1-01-2004 7-01-2004 1-01-2005 7-01-2005
SP 500 Fixed Weights Dynamic Weights Fixed Weights (without short) Dynamic Weights (without short)
Conclusion
Multi-factor model strategy outperforms universe return (e.g. S&P500)
Dynamic weight strategy outperform fixed weight strategy
Future consideration:Transaction cost should be considered to evaluate strategies