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Language of Risk
Feb 1, 2007
In this issue, we attempt to bridge two sources of risk that we have not treated together in the past: trading risk and governance risk. To motivate our approach, we first review both our equity factor model for risk and our (in the sense of the greater RiskMetrics Group) scheme to quantify governance quality. We then mesh these two models to build an equity factor based on governance. Creating a factor, though, is the easy part, and our greater goal is to assess the factor along the dimensions of intuition, returns, and risk. Our governance factor does appear to generate excess returns consistent with other governance factors in the literature, and it adds to our ability to explain the risk in the broad equity market, similarly to other established factors.
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