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Nonlinear Models: Are They Useful in Forecasting Risk and Expected Return?

categories: Factor and Risk Modeling, PMA, Equities, Research Paper, GRINOLD Richard, general

Nonlinear Models: Are they useful in forecasting risk and expected return? It helps to examine the foundations every so often. One of Barra's basic concepts is the linear model of asset risk. We examined that concept during our June, 1991EquityResearch seminar. The seminar section looked at two particular nonlinear effects. The first was the  relationship between asset specific return and asset exposure to a risk index. The second was the relationship between factor return and exposure to a risk index. We will examine each of these in turn.