Methodology

Multi-Factor Models

Using Multi-Factor Models

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).  

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.

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. 

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%. 

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