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This Model Insight describes the methodological advances that underpin the new Barra US Equity Model (USE4). One highlight of the USE4 Model is the Optimization Bias Adjustment, which builds corrections directly into the factor covariance matrix to reduce the forecasting biases of optimized portfolios. Another modeling innovation is the Volatility Regime Adjustment, which uses cross-sectional observations to calibrate factor volatilities and specific risk to current market levels. We discuss the advantages of the USE4 Country factor, and provide an interpretation of the factor portfolios. We also describe the USE4 specific risk model, which incorporates a Bayesian adjustment technique to remove known biases from the specific risk forecasts.
Topic: Factor and Risk Modeling
Asset Types: Equities