Question

As opposed to the single factor approach, discuss the importance of a multi-factor approach to investing? (100 words)

Answer 1

Reaping of diversification of risk from multi factor approach attracting the various participants of Investors. Multi factor portfolio can be used to designed to diversify factor risk. While applying the multi factor approach various factors can grouped and tested for good return and reduced risk. Market risk is a important part of the overall risk in multi factor approach.

Single factor approch considers only one factor at a time however multi factor approach may contain factors like value, risk, size, quality.

Formula for multi factor model can be -

R = ai + _i(m) * Rm + _i(1) * F1 + _i(2) * F2 +...+_i(N) * FN + ei

e is error term

F1,2,3.. is the factor

Rm is the return on market

R is return on stock.

_ is the beta