Multiple Alpha Sources and Active Management

Sorensen, Eric H.; Qian, Edward E.; Schoen, Robert; Hua, Ronald

doi:10.3905/jpm.2004.319928

Cited by 22 publications

(3 citation statements)

References 3 publications

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“…Multifactor models offer diversification among factors and can improve the information ratio of the overall model (see Sorensen et al [2004]). Drawing on the results so far, we analyze the turnover of multifactor models by studying their forecast autocorrelation.…”

Section: Turnover Of Multifactor Modelsmentioning

confidence: 99%

“…To integrate an alpha model with portfolio turnover, we extend work by and Sorensen et al [2004] that provides an optimal solution for FALL 2007 multifactor models with the objective of the highest information ratio. This work relies heavily on the time series correlation of information coefficients (IC) as well as contemporaneous correlations between factor signals.…”

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confidence: 99%

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Information Horizon, Portfolio Turnover, and Optimal Alpha Models

Qian¹,

Sorensen²,

Hua³

2007

JPM

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T he bottom-line value of an active investment process has two parts: the theoretical value of the alpha skill (the gross paper profit), minus the cost of implementation. The higher the former and the lower the latter, the happier the investor is. Clearly total assets under management (AUM) influence the latter. A strategy might be profitable with a low level of assets under management but unprofitable with more assets-as asset amounts grow, so do transaction costs.Kahn and Shaffer [2005] note that one approach to remedy the size problem is to reduce portfolio turnover. While this is a sensible suggestion, Kahn and Shaffer's work is based on a hypothetical relation between turnover and expected alpha that might be too general to be applicable. In reality, any relation between turnover and expected alpha is not exogenous. It depends on alpha factors, their weights in an alpha model, and the rebalance horizon.We propose an analytic framework for integrating alpha models with portfolio turnover. In practice, many alpha models are not constructed in such an integrated framework. Typically, managers first develop an alpha model (giving little consideration to turnover), and then throw the alpha model into an optimizer, setting turnover constraints to handle the transaction costs. There are two drawbacks to this two-step process: 1) It makes it hard to know the true effectiveness of the alpha model; and 2) it does not let managers adjust the alpha model along the way as AUM grow.To integrate an alpha model with portfolio turnover, we extend work by Qian and Hua [2004] and Sorensen et al. [2004] that provides an optimal solution for Information Horizon, Portfolio Turnover, and Optimal Alpha Models

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Section: Turnover Of Multifactor Modelsmentioning

confidence: 99%

mentioning

confidence: 99%

Information Horizon, Portfolio Turnover, and Optimal Alpha Models

Qian¹,

Sorensen²,

Hua³

2007

JPM

Self Cite

View full text Add to dashboard Cite

show abstract

“…We now know more about how to optimally combine alpha sources (Sorensen, Hua, and Qian [2004]), and we have created innovative approaches to measure the importance of alpha sources based on their context. Contextual modeling provides deeper fundamental insight by formally ascribing the importance of a set of model inputs based on the homogeneity of a set of stocks within a group according to risk fundamentals and characteristics (Sorensen et al [2005]).…”

Section: The Future: Shining the Light In The Right Spotmentioning

confidence: 99%