Factor Investing Strategies

This course outlines how to apply factor models to generate alpha, to hedge against direction and to select the best instruments for a trade.

Factor models such as PCA allow investors to gain insights into market mechanisms and to translate these into profitable trading strategies and asset selection decisions. Moreover, factor models can be used to assess the exposure of a portfolio to the direction of the market and to hedge it appropriately. Numerous hands-on exercises and case studies will teach participants how to exploit factor models for the benefit of their work.

As the factors and non-directional trading strategies constructed with factor models are mean reverting, the return prediction techniques from the Statistical Arbitrage course can be applied. While both stat arb courses together provide the full toolkit, they can be taken independently of each other.

May 18 to May 19, 2017
Duration: Two days (9.00am to 5.00pm)
Location: The Tower Hotel – London, UK
Trainer: Christian Schaller
Course fee: £1790 + VAT – Register online

DAY 1

Link between factor models and mean reversion
Overview of factor models and the advantages of PCA (principal component analysis)
Theory of PCA

+ Mathematical definitions
+ Basic factor equations
+ Covariance matrices
+ Eigenvectors and Eigenvalues

Computational aspects
Interpretation of the results
Gaining insights into market mechanisms through the eigenvectors and factors of a PCA

+ What drives markets and how?
+ How strong are directional impacts on spread trades?
+ How will markets react to external shocks, e.g. the vol surface to a data release?

Using PCA to understand the driving forces of several markets

+ Bond markets: How do directional moves impact the yield curve?
+ How steep is the yield curve after taking the yield level into account?
+ Credit markets: Decomposing corporate bond price action into a rating factor and a sector factor
+ Option markets: Decomposing the vol surface by expiries and underlyings
+ Commodity markets: Analysing crack and crush spreads net of the direction
+ FX markets: Which currencies tend to move together?
+ What drives the relative valuation of these clusters of currencies?
+ Equity markets: Establishing an analytical basis for pairs trading (discussed on day 2)

DAY 2: Factor Models for Trading

Decomposing a market into directional (beta) and non-directional (alpha) factors
Calculating hedge ratios through PCA
Constructing trades with a defined factor exposure and hedged against all other factors

+ Gaining exposure to a single factor
+ Gaining exposure to residuals rather than factors
+ Hedging against one or more factors

Using PCA to analyse the exposure of trading positions and investment portfolios
Using PCA for market reconstruction and forecasting
Using PCA to screen the market for trading opportunities
Using PCA for asset selection
Combining the elements into a step-by-step guide for PCA-based analysis and trading
Potential problems and pitfalls of PCA-based trading

+ Correlation of factors during subperiods
+ Changing eigenvectors
+ How to monitor and address these problems

Using PCA to construct trading strategies

+ Scenario analysis: How should we expect the US yield curve to react to a rate hike?
+ Screening bond and equity markets for trade ideas
+ Asset selection: analyzing PCA residuals to choose the best instruments to express a view
+ Hedging a portfolio via factor immunization
+ Constructing pairs trades
+ Trading the option vol surface
+ Trades between different asset classes