dynamic factor weights red devil partners joon seong choi, youngjun yoo, richard park, yk kim
TRANSCRIPT
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