Book

"Risk and Asset Allocation" - Springer, by Attilio Meucci

Textbook: Linear Factor Models

Risk and Asset Allocation, Springer 2005

In this Chapter, we discuss the main dimension-reduction techniques: explicit-factor approaches, such as regression analysis, and hidden-factor approaches, such as principal component analysis and idiosyncratic factors. To support intuition we stress the geometric interpretation of these approaches in terms of the location-dispersion ellipsoid. Finally we present a useful routine to perform dimension reduction in practice in a variety of contexts, including portfolio replication.

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