Moment Fusing: An Informed Construction of Pricing Factors
Stuart School of Business research presentation by: Assistant Professor of Finance Kingway Chun-Wei Lin, Ngoc-Khanh Tran, and Guofu Zhou
Moment Fusing: An Informed Construction of Pricing Factors
- Assistant Professor of Finance Kingway Chun-Wei Lin
- Ngoc-Khanh Tran, Virginia Tech
- Guofu Zhou, Washington University in St. Louis
Abstract:
Existing PCA methods identify common risk factors while ignoring information about expected returns. We propose a general and flexible moment-fusing approach that incorporates risk prices directly into the identification of risk factors. Specifically, we construct a return transformation such that the volatilities of the transformed returns are proportional to the Sharpe ratios of the original assets. We then perform factor analysis on the transformed returns, with or without additional pricing restrictions. Empirically, we find that the moment-fusing factors significantly outperform leading benchmark models in pricing both FX and equity portfolios out-of-sample.
All Illinois Tech faculty, students, and staff are invited to attend.
The Friday Research Presentations series showcases ongoing academic research projects conducted by Stuart School of Business faculty and students, as well as guest presentations by Illinois Tech colleagues, business professionals, and faculty from other leading business schools.