Multi-Factor Models

Using Multi-Factor Models

1

Multi-factor models are usually quite intimidating for people and difficult to produce. The easiest way to produce multi-factor models is to use statistical software like SPSS (paid for) or Gretl (free). 

2

A general formula for a multi-factor model is: Ri = ai + ßi (m) Rm + ßi (1)F1 + ßi (2)F2 +…+ ßi (N)FN + ei.

 

Where Ri is the return of a stock/portfolio, ai is the intercept, Bi (m) is the beta of the market, Rm is the return of the market, Bi (number) is the beta of a specific variable, F (number) represent a different variable and ei is the error.

3

When it comes to the beta of each variable, this is the figure that will tell how much the stock will change for every unit of that variable that changes. 

4

For example, if we decide to include interest rate as a variable and the beta comes back as 10, this would mean that for every 1% that interest rates increase, the stock would increase by 10%.

Test your knowledge...

1. How much can you expect to earn from a cash investment?

Copyright © 2021 Methodology

That's wrong - try again!