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Portfolio risk management in a data-rich environment

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  • Mohammed Bouaddi
  • Abderrahim Taamouti

Abstract

We study risk assessment using an optimal portfolio in which the weights are functions of latent factors and firm-specific characteristics (hereafter, diffusion index portfolio). The factors are used to summarize the information contained in a large set of economic data and thus reflect the state of the economy. First, we evaluate the performance of the diffusion index portfolio and compare it to both that of a portfolio in which the weights depend only on firm-specific characteristics and an equally weighted portfolio. We then use value-at-risk, expected shortfall, and downside probability to investigate whether the weights-modeling approach, which is based on factor analysis, helps reduce market risk. Our empirical results clearly indicate that using economic factors together with firm-specific characteristics helps protect investors against market risk. Copyright Swiss Society for Financial Market Research 2012

Suggested Citation

  • Mohammed Bouaddi & Abderrahim Taamouti, 2012. "Portfolio risk management in a data-rich environment," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(4), pages 469-494, December.
    • Handle: RePEc:kap:fmktpm:v:26:y:2012:i:4:p:469-494
    DOI: 10.1007/s11408-012-0199-9
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    More about this item

    Keywords

    Portfolio weights modeling; Factor analysis; Principal components; Portfolio performance; Value-at-risk; Expected shortfall; Downside probability; C13; C43; G11; G19;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G19 - Financial Economics - - General Financial Markets - - - Other

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