Research Articles

In this study, our goal is to adapt mean-variance optimization to produce active portfolios with less exposure to extreme losses than normal optimized portfolios. Specifically, we illustrate how extreme risk can be incorporated into portfolio construction in a straightforward way by constraining the shortfall beta of the optimal portfolio. Our simple empirical examples suggest that constraining shortfall beta may offer some downside protection in turbulent periods without sacrificing performance over longer periods.

Publication: MSCI Barra Research Insight
Authors: BENDER Jennifer, LEE Jyh-Huei, STEFEK Dan

This paper analyzes the impact of constraints on portfolio return and risk, extending the insights of previous research in this area. We show that constraints move a manager's portfolio away from the optimal unconstrained portfolio in two ways. First, they may rein in or increase the risk of the portfolio without impairing its information ratio. Second, they may force the portfolio to take unwanted bets that incur risk but yield no return. As a result, a constrained portfolio consists of positions that are aligned with the manager's alphas and positions that are orthogonal to the alphas but are adopted to satisfy the constraints. We illustrate how to measure the risk and return arising from each of these sources and how to drill down to examine the contributions of individual constraints.

Publication: MSCI Barra Research Insights
Authors: BENDER Jennifer, LEE Jyh-Huei, STEFEK Dan

The misalignment of alpha and risk factors may result in inadvertent and unwanted bets that may hamper performance. Lee and Stefek (2008) show that better aligning risk factors with alpha factors may improve the information ratio of optimized portfolios. They propose four ways of modifying a risk model to reduce misalignment. Here, we discuss one way to mitigate these problems by modifying the optimization process, itself. The objective function is modified to include a penalty term on the residual alpha. In our examples, the method proposed helps to mitigate the mismatch between alpha and risk by assigning a suitable penalty to the residual alpha.

Publication: MSCI Barra Research Insights
Authors: BENDER Jennifer, LEE Jyh-Huei, STEFEK Dan

Portfolio managers worry that discrepancies between risk and alpha factors may create unintended biases in their optimized portfolios. We analyze the ramifications of using different factor models of risk and alpha in portfolio optimization and show that aligning risk factors with alpha factors may improve the information ratio of optimized portfolios, even if doing so lowers the overall accuracy of risk forecasts. We discuss ways of modifying a risk model that may help remedy these problems.

Publication: The Journal of Portfolio Management
Authors: LEE Jyh-Huei, STEFEK Dan

In the Autumn 2002 edition of Horizon, we introduced our new framework for global risk analysis, the Barra Integrated Model. This multi asset class framework was developed with two goals in mind: breadth of coverage and in-depth analysis. Risk analysis using the Integrated Model allows investment professionals to capture the detail available with local market models while retaining the broad perspective of a global, multi asset class model. To achieve these objectives, we first built models for three separate asset classes: global equities, global bonds and currencies.  The general methodology for constructing these models was described in Part One. In this article, we more fully specify the structure for each asset class.

Publication:
Authors: STEFEK Dan

Barra has recently released the Barra Integrated Model, a multi-asset class model for forecasting the asset and portfolio level risk of global equities, bonds, and currencies. The model uses innovative methods to couple broad asset coverage with the detailed analysis of Barra's models that focus on particular markets. This makes it suitable for a wide range of investment purposes, from conducting an in-depth analysis of a single-country portfolio to understanding the risk profile of a broad set of international investments. This article introduces the general modeling framework and methodology used to construct the Integrated Model. We first give an overview of our aims and approach. We then describe the common basic structure used to build two components of the Integrated Model – a global equity and a global bond model. Future articles will expand on these global asset-class models and describe how they are integrated.

Publication:
Authors: STEFEK Dan

The authors of this article view the international equity market through the lens of a multiple-factor risk model.  They find that the most important attribute of a company is its country. Industry is also important. Industries linked by commodity prices and markets (energy, banks, casualty insurance, and metals) are more significant than unconnected industries (consumer goods). The importance of industries has not increased from 1983 through 1988.

Publication: Journal of Portfolio Management
Authors: GRINOLD Richard, RUDD Andrew, STEFEK Dan