CME, Multifactor capital, filter, anybody, txtbook

DoubleDip

In the capital mrkts expectations section, is anybody understanding the way the CFAI txtbook calculates covariance using multifactor models? What a mess. Why multifactor model "filter" out noise and simplify task of estimating covariance? Thanks in advance

Analyze_This

Oh yeah perfect, I understand now. For the exam, are you studying the formula for the 2-factor covariance? Thanks

nannan66

mik, I'm already done with the CFA exams. You might have to check out LOS to see what's required. Good luck!

Windjam

Conceptually, when you introduce structure (such as a factor model) the number of parameters that you need to estimate goes down. That reduces impact of noise (spurious correlations) and simplifies covariance estimation. for example, if you have n assets, without factor models you would have to estimate n*(n+1)/2 parameters. With one factor model, you would need to estimate n + n + 1 = 2n+1 (n betas, n residuals and market variance). Does that help?