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Alpha forecasting in factor investing: discriminating between the informational content of firm characteristics

Author

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  • Lars Heinrich

    (W&W Asset Management GmbH)

  • Martin Zurek

    (Viadrina European University)

Abstract

This paper applies a linear alpha forecasting framework to enhance commonly used factor investing strategies by taking into account the informational content and interaction effects of selected firm characteristics. To demonstrate conditions under which it is beneficial to deviate from equally weighted characteristics, we evaluate a comprehensive number of factor portfolios. We consider four single-factor portfolios with 14 different firm characteristics in total and a multifactor portfolio where all factors are included. Empirically, the strategies are analyzed with the S&P 500, the Stoxx Europe 600 and the Nikkei 225 index. In addition, we also examine the strategies’ performance in a simulation experiment and investigate the properties of the information coefficient estimates as a measure of the informational content. The empirical results are consistent with the simulation results, which reveal that the overall portfolio performance can be improved in well-defined factor models with a high dispersion among the mean information coefficients of the firm characteristics. In contrast, the naïve combination shows a comparable or better performance in factor models with a small dispersion in informational content between firm characteristics.

Suggested Citation

  • Lars Heinrich & Martin Zurek, 2019. "Alpha forecasting in factor investing: discriminating between the informational content of firm characteristics," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 33(3), pages 243-275, September.
    • Handle: RePEc:kap:fmktpm:v:33:y:2019:i:3:d:10.1007_s11408-019-00333-4
    DOI: 10.1007/s11408-019-00333-4
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    References listed on IDEAS

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    Cited by:

    1. Lars Heinrich & Antoniya Shivarova & Martin Zurek, 2021. "Factor investing: alpha concentration versus diversification," Journal of Asset Management, Palgrave Macmillan, vol. 22(6), pages 464-487, October.
    2. Martin Zurek & Lars Heinrich, 2021. "Bottom-up versus top-down factor investing: an alpha forecasting perspective," Journal of Asset Management, Palgrave Macmillan, vol. 22(1), pages 11-29, February.

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    More about this item

    Keywords

    Factor investing; Multifactor; Alpha forecasting; Stock screening; Z-score; Information coefficient; Optimal orthogonal portfolio;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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