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Dan Stefek

Research and Insights

Articles by Dan Stefek

    Alpha-Risk Factor Misalignment

    Research Report | Jan 15, 2013 | Oleg Ruban , Dan Stefek , Jyh-huei Lee , Jay Yao

    Portfolio managers have long worried that discrepancies between risk and alpha factors may somehow detract from the performance of their optimized portfolios. This paper presents a comprehensive overview of alpha-risk factor alignment and its consequences, showing how penalizing the residual alpha may help reduce the unintended bets resulting from misalignment. However, we also illustrate that correcting for misalignment may not always be necessary and can sometimes be...

    Manager Crowding and Portfolio Construction

    Research Report | Oct 10, 2012 | Oleg Ruban , Dan Stefek , Jyh-huei Lee , Jay Yao

    Following the “quant meltdown” of August 2007, market observers became concerned that quant strategies were leading to crowded trades. This paper analyzes the impact that a risk model used in portfolio construction has on manager crowding by identifying the drivers of crowding and by illustrating their impact.  A risk model’s effect on manager crowding depends, in part, on how alphas used by different managers are related to each other, and to the risk model factors. We...

    Model Insight - The MSCI Bond Liquidity Measure (BLM) - Sep. 2012

    Research Report | Sep 28, 2012 | Dan Stefek , Zsolt Szekeres , Carlo Acerbi

    This Model Insight introduces the MSCI Bond Liquidity Measure (BLM), a model-based estimate of bond bid-ask spreads for a broad universe of quoted and non-quoted bonds. The BLM provides both a liquidity scoring metric and a way to quantify potential transaction costs. Applications of BLM include portfolio construction, risk control, risk limits, regulatory compliance, and liquidity provisioning.  Furthermore, BLM opens the way  for the consistent assessment of liquidity...

    Is Your Risk Model Letting Your Optimized Portfolio Down?

    Research Report | Aug 23, 2012 | Oleg Ruban , Dan Stefek , Jyh-huei Lee , Jay Yao

    Many portfolio managers use multi-factor models, but not all factor models are equally effective in forecasting risk.

    Model Insight - Barra Private Equity Model (PEQ1) Overview - July 2012

    Research Report | Jul 14, 2012 | Dan Stefek , Katalin Varga , Raghu Suryanarayanan

    Focused on US Buyouts and Ventures, the new Barra Private Equity Model (PEQ1) attributes risk to intuitive public equity and private equity investment type factors, reflects changes in risk in a more timely fashion than traditional methods, and captures the relationship between public and private equity. 

    Mitigating Risk Forecast Biases of Optimized Portfolios

    Research Report | Sep 26, 2011 | Dan Stefek , Rong Xu , Jyh-huei Lee , Jay Yao

    Portfolio managers have long suspected that the risk forecast of an optimized portfolio tends to be optimistic. Many have identified the culprit as estimation error in the covariance matrix. Forecasts based on historical asset covariance matrices are particularly sensitive to this error. The bias is reduced dramatically by using a factor model. Even so, factor models still tend to under-forecast the risk of optimized portfolios, especially the risk coming from factors. In this paper, we show...

    Risk Forecast Biases of Optimized Portfolios - A Quantitative Analysis

    Research Report | Sep 20, 2011 | Dan Stefek , Rong Xu , Jennifer Bender , Jyh-huei Lee , Jay Yao

    Portfolio managers have long suspected that the risk forecast of an optimized portfolio tends to be optimistic. Many have identified the culprit as estimation error in the covariance matrix. Forecasts based on historical asset covariance matrices are particularly sensitive to this error. The bias is reduced dramatically by using a factor model. Even so, factor models still tend to under-forecast the risk of optimized portfolios, especially the risk coming from factors. In this paper, we show...

    Private and Public Real Estate - What is the Link?

    Research Report | Jun 16, 2010 | Dan Stefek , Raghu Suryanarayanan

    In this paper, we study the relationship between private and public real estate in the US and UK markets and demonstrate a strong link between returns in each of these markets. To uncover these relationships, we correct for appraisal smoothing and properly account for the lead-lag relationship between public and private returns. We find that public returns lead private returns, even after removing appraisal smoothing in private returns. We also discuss how real estate risk...

    Constraining Shortfall

    Research Report | Apr 20, 2010 | Dan Stefek , Jennifer Bender , Jyh-huei Lee

    In this study, our goal is to adapt mean-variance optimization to produce active portfolios with less exposure to extreme losses than normal optimized portfolios. Specifically, we illustrate how extreme risk can be incorporated into portfolio construction in a straightforward way by constraining the shortfall beta of the optimal portfolio. Our simple empirical examples suggest that constraining shortfall beta may offer some downside protection in turbulent periods without sacrificing...

    Forecast Risk Bias in Optimized Portfolios

    Research Report | Oct 1, 2009 | Dan Stefek , Jay Yao , Jennifer Bender , Jyh-huei Lee

    When there is noise in a covariance matrix, portfolio optimization tends to produce portfolios for which the risk forecasts are underestimates of the true risk. In this paper, we take a closer look at the connection between estimation error and the underestimation of the risk of optimized portfolios. We pay special attention to the case in which returns have a known factor structure. There, the bias in optimization can be reduced dramatically by using a covariance matrix based on a factor...

    Decomposing the Impact of Portfolio Constraints

    Research Report | Aug 1, 2009 | Dan Stefek , Jennifer Bender , Jyh-huei Lee

    This paper analyzes the impact of constraints on portfolio return and risk, extending the insights of previous research in this area. We show that constraints move a manager's portfolio away from the optimal unconstrained portfolio in two ways. First, they may rein in or increase the risk of the portfolio without impairing its information ratio. Second, they may force the portfolio to take unwanted bets that incur risk but yield no return. As a result, a constrained portfolio consists of...

    Refining Portfolio Construction by Penalizing Residual Alpha - Empirical Examples

    Research Report | Jun 1, 2009 | Dan Stefek , Jennifer Bender , Jyh-huei Lee

    Misalignment between alpha and risk factors may create unintended bets in optimized portfolios, as shown analytically in Lee and Stefek (2008).  In a March research insight, we introduced a way to mitigate this issue by penalizing the portion of the alpha not related to the risk factors, the 'residual alpha.' Here, we further illustrate this method with two signals commonly used by portfolio managers. The potential improvement from this method depends on the strategy in question, in...

    Refining Portfolio Construction When Alphas and Risk Factors Are Misaligned

    Research Report | Mar 1, 2009 | Dan Stefek , Jennifer Bender , Jyh-huei Lee

    The misalignment of alpha and risk factors may result in inadvertent and unwanted bets that may hamper performance. Lee and Stefek (2008) show that better aligning risk factors with alpha factors may improve the information ratio of optimized portfolios. They propose four ways of modifying a risk model to reduce misalignment. Here, we discuss one way to mitigate these problems by modifying the optimization process, itself. The objective function is modified to include a penalty term on the...

    Portfolio of Risk Premia: A New Approach to Diversification

    Research Report | Jan 1, 2009 | Dan Stefek , Frank Nielsen

    Traditional asset allocation approaches have not provided the full potential of diversification. Here, we introduce a different approach and look at structuring portfolios using risk premia within the traditional asset classes or from systematic trading strategies. We confirm the potential benefits of such an approach by comparing a typical 60/40 equity/fixed income allocation with an equal weighted allocation across eleven risk premia.

    Do Risk Factors Eat Alphas?

    Research Report | Apr 1, 2008 | Dan Stefek , Jyh-huei Lee

    Portfolio managers worry that discrepancies between risk and alpha factors may create unintended biases in their optimized portfolios. We analyze the ramifications of using different factor models of risk and alpha in portfolio optimization and show that aligning risk factors with alpha factors may improve the information ratio of optimized portfolios, even if doing so lowers the overall accuracy of risk forecasts. We discuss ways of modifying a risk model that may help remedy these problems.

    The Barra Integrated Model - Version 204

    Research Report | Sep 1, 2005 | Dan Stefek , Anton Puchkov , Agnes Hsieh , Fati Hemmati

    The Barra Integrated Model (BIM) is a multi-asset class model for forecasting the asset and portfolio level risk of global equities, bonds, currencies, and commodities. The model uses innovative methods to couple broad asset coverage with the detailed analysis of Barra's models that focus on particular markets. This makes it suitable for a wide range of investment purposes, from conducting an in-depth analysis of a single-country portfolio to understanding the risk profile of a broad set of...

    The Barra Integrated Model - Part 2

    Research Report | Jan 1, 2003 | Dan Stefek

    In the Autumn 2002 edition of Horizon, we introduced our new framework for global risk analysis, the Barra Integrated Model. This multi asset class framework was developed with two goals in mind: breadth of coverage and in-depth analysis. Risk analysis using the Integrated Model allows investment professionals to capture the detail available with local market models while retaining the broad perspective of a global, multi asset class model. To achieve these objectives, we first built models...

    The Barra Integrated Model - Part 1

    Research Report | Jan 1, 2002 | Dan Stefek

    Barra has recently released the Barra Integrated Model, a multi-asset class model for forecasting the asset and portfolio level risk of global equities, bonds, and currencies. The model uses innovative methods to couple broad asset coverage with the detailed analysis of Barra's models that focus on particular markets. This makes it suitable for a wide range of investment purposes, from conducting an in-depth analysis of a single-country portfolio to understanding the risk profile of a broad...

    The Barra Integrated Model

    Research Report | Jan 1, 2002 | Dan Stefek

    The Barra Integrated Model is a multi-asset class model for forecasting the asset and portfolio level risk of global equities, bonds and currencies. The model uses innovative methods to couple broad asset coverage with the detailed analysis of Barra's models that focus on particular markets. This makes it suitable for a wide range of investment purposes, from conducting an in-depth analysis of a single-country portfolio to understanding the risk profile of a broad set of international...

    The Barra Integrated Model

    Research Report | Jan 1, 2002 | Dan Stefek

    The Barra Integrated Model is a multi-asset class model for forecasting the asset and portfolio level risk of global equities, bonds and currencies.  The model uses innovative methods to couple broad asset coverage with the detailed analysis of Barra's models that focus on particular markets.  This makes it suitable for a wide range of investment purposes, from conducting an in-depth analysis of a single-country portfolio to understanding the risk profile of a broad set of...