Equity Valuation and Portfolio Management

FRANK J. FABOZZI, PHD, CFA, is Professor of Finance at EDHEC Business School and a member of the EDHEC-Risk Institute. Prior to joining EDHEC in August 2011, he held various professorial positions in finance at the Yale School of Management from 1994 to 2011 and was a visiting professor of finance and accounting at the MIT Sloan School of Management from 1986 to 1992. He is also Editor of the Journal of Portfolio Management.HARRY M. MARKOWITZ, PHD, is a consultant in the area of finance. In 1990, he was awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel for his groundbreaking work in portfolio theory. In 1989, he received the John von Neumann Theory Prize of the Institute for Operations Research and the Management Sciences for his work in portfolio theory and other applications of mathematics and computers to business practice.

• Preface xiiiAbout the Editors xxiiiContributing Authors xxvChapter 1 An Introduction to Quantitative Equity Investing 1Paul BukowskiEquity Investing 1Fundamental vs. Quantitative Investor 2The Quantitative Stock Selection Model 7The Overall Quantitative Investment Process 9Research 9Portfolio Construction 18Monitoring 21Current Trends 22Key Points 23Questions 24Chapter 2 Equity Analysis Using Traditional and Value-Based Metrics 25James L. Grant and Frank J. FabozziOverview of Traditional Metrics 25Price Multiples 32Fundamental Stock Return 36Traditional Caveats 38Overview of Value-Based Metrics 39Key Points 58Appendix: Case Study 60Questions 69Chapter 3 A Franchise Factor Approach to Modeling P/E Orbits 71Stanley Kogelman and Martin L. LeibowitzBackground 72Historical Data Observations 75Formulation of the Basic Model 81P/E Myopia: The Fallacy of a Stable P/E 85Two-Phase P/E Orbits 91Franchise Valuation under Q-Type Competition 96Franchise Labor 97Key Points 101Questions 102Chapter 4 Relative Valuation Methods for Equity Analysis 105Glen A. Larsen Jr., Frank J. Fabozzi, and Chris GowllandBasic Principles of Relative Valuation 106Hypothetical Example 115Key Points 123Questions 124Chapter 5 Valuation over the Cycle and the Distribution of Returns 125Anders Ersbak Bang Nielsen and Peter C. OppenheimerThe Link Between Earnings and Returns 126The Phases Can Be Interpreted in Relationship to the Economy 132Asset Class Performance Varies across the Phases 137Incorporating Cyclicality into Valuations 139Appendix: Dates and Returns of the Phases 142Key Points 146Questions 146Chapter 6 An Architecture for Equity Portfolio Management 147Bruce I. Jacobs and Kenneth N. LevyArchitectural Building Blocks 148Traditional Active Management 151Passive Management 156Engineered Management 157Expanding Opportunities 160The Risk-Return Continuum 163The Ultimate Objective 167Key Points 168Questions 169Chapter 7 Equity Analysis in a Complex Market 171Bruce I. Jacobs and Kenneth N. LevyAn Integrated Approach to a Segmented Market 172Disentangling 176Constructing, Trading, and Evaluating Portfolios 184Profiting from Complexity 186Key Points 187Questions 188Chapter 8 Survey Studies of the Use of Quantitative Equity Management 189Frank J. Fabozzi, Sergio M. Focardi, and Caroline L. Jonas2003 Intertek European Study 1892006 Intertek Study 1972007 Intertek Study 205Challenges for Quantitative Equity Investing 224Modeling After the 2007–2009 Global Financial Crisis 226Key Points 228Questions 229Chapter 9 Implementable Quantitative Equity Research 231Frank J. Fabozzi, Sergio M. Focardi, and K. C. MaThe Rise of Econophysics 233A General Framework 235Select a Sample Free from Survivorship Bias 238Select a Methodology to Estimate the Model 239Risk Control 246Key Points 248Questions 249Chapter 10 Tracking Error and Common Stock Portfolio Management 251Raman Vardharaj, Frank J. Fabozzi, and Frank J. JonesDefinition of Tracking Error 251Components of Tracking Error 254Forward-Looking vs. Backward-Looking Tracking Error 255Information Ratio 256Determinants of Tracking Error 257Marginal Contribution to Tracking Error 261Key Points 262Questions 263Chapter 11 Factor-Based Equity Portfolio Construction and Analysis 265Petter N. Kolm, Joseph A. Cerniglia, and Frank J. FabozziFactor-Based Trading 266Developing Factor-Based Trading Strategies 269Risk to Trading Strategies 271Desirable Properties of Factors 273Sources for Factors 273Building Factors from Company Characteristics 274Working with Data 275Analysis of Factor Data 283Key Points 287Questions 289Chapter 12 Cross-Sectional Factor-Based Models and Trading Strategies 291Joseph A. Cerniglia, Petter N. Kolm, and Frank J. FabozziCross-Sectional Methods for Evaluation of Factor Premiums 292Factor Models 300Performance Evaluation of Factors 310Model Construction Methodologies for a Factor-based Trading Strategy 317Backtesting 328Backtesting Our Factor Trading Strategy 330Key Points 331Appendix: The Compustat Point-in-Time, IBES Consensus Databases and Factor Definitions 333Questions 337Chapter 13 Multifactor Equity Risk Models and Their Applications 339Anthony Lazanas, António Baldaque da Silva, Arne D. Staal, and Cenk UralMotivation 340Equity Risk Factor Models 342Applications of Equity Risk Models 350Key Points 370Questions 371Chapter 14 Dynamic Factor Approaches to Equity Portfolio Management 373Dorsey D. FarrMethods of Active Management 376Modeling 385Implementation 392Key Points 395Questions 395Chapter 15 A Factor Competition Approach to Stock Selection 397Joseph Mezrich and Junbo FengThe Problem 397The Solution 403Which Factors Get Picked? 407Does the Alpha Repair Process Work? 408Key Points 411Questions 412Chapter 16 Avoiding Unintended Country Bets in Global Equity Portfolios 413Michele Aghassi, Cliff Asness, Oktay Kurbanov, and Lars N. NielsenCountry Membership and Individual Stock Returns 414Ways to Build Active Global Portfolios 416Studying the Naive Portfolio 419Empirical Results 420Why Does the Naive Stock Selection Portfolio Make Country Noise Bets? 422Key Points 423Questions 424Chapter 17 Modeling Market Impact Costs 425Petter N. Kolm and Frank J. FabozziMarket Impact Costs 426Liquidity and Transaction Costs 427Market Impact Measurements and Empirical Findings 430Forecasting and Modeling Market Impact 433Key Points 439Questions 440Chapter 18 Equity Portfolio Selection in Practice 441Dessislava A. Pachamanova and Frank J. FabozziPortfolio Constraints Commonly Used in Practice 442Benchmark Exposure and Tracking Error Minimization 450Incorporating Transaction Costs 454Incorporating Taxes 460Multi-Account Optimization 465Robust Parameter Estimation 469Portfolio Resampling 471Robust Portfolio Optimization 474Key Points 480Questions 481Chapter 19 Portfolio Construction and Extreme Risk 483Jennifer Bender, Jyh-Huei Lee, and Dan StefekMeasures of Extreme Loss 484Constraining Shortfall 485Performance 485Imposing Benchmark Neutrality 487Analysis 489Key Points 493Appendix: Constructing Out-of-Sample Shortfall Betas 494Questions 495Chapter 20 Working with High-Frequency Data 497Irene AldridgeWhat is High-Frequency Data? 497How is High-Frequency Data Recorded? 499Properties of High-Frequency Data 500High-Frequency Data are Voluminous 501High-Frequency Data are Subject to Bid-Ask Bounce 503High-Frequency Data are Irregularly Spaced in Time 509Equity Correlations Decay at High Frequencies 517Key Points 519Questions 520Chapter 21 Statistical Arbitrage 521Brian J. JacobsenPairs Trading 523General Models 532Key Points 534Questions 534About the Website 535Index 537