Multiple factor models for equities

An empirical study of the performance of factor mimicking

portfolios

Students
Christoffer Forssén
Gustav Åhs

Spring 2017
Master thesis, 30 ECTS
Master of Science in Engineering and Management, 300 ECTS
Abstract

The trade-off between risk and return for equities has long been a challenge for portfolio
and risk managers in order to create financial success and stability. This issue has led to
several researchers trying to explain equity returns through various factor models. The
capital asset-pricing model (CAPM) formulated by Sharpe (1964), Lintner (1965), and
Black (1972) was the first model explaining the relation between cross-sectional returns
relative the broad market index. Since then, factor models have evolved and
fundamental multiple factor models have been found to successfully explain the risk
structure of equities, through linear combinations of firm specific data and market data.

In this paper, we implement and analyze a fundamental factor model. The objective is to
build a dynamic and robust model that provide portfolio and risk managers with insight
of what drives returns and risks of equities and portfolios. A key to understand the
advantages of factor models lies in the characteristics of factors and the concept of
factor mimicking portfolios, whose return perfectly replicates those of factors. These
portfolios are derived through cross-sectional regressions of security returns and
standardized exposure towards factors, which results in portfolios with a desired
exposure. The model implementation is applied and evaluated for both a European and
Swedish estimation universe, and the result indicate that some factor mimicking
portfolios yield an excess return relative the market during 2015-01-01 to 2017-01-01.

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Sammanfattning

Avvägningen mellan risk och avkastning för aktier har länge varit en utmaning för
portföljförvaltare och riskanalytiker, vars syfte är att skapa ekonomisk framgång och
stabilitet. Denna fråga har lett till att forskare försökt förklara aktiers avkastning genom
olika faktormodeller. Capital-asset-pricing model (CAPM) som formulerades av Sharpe
(1964), Lintner (1965) och Black (1972) var den första modellen som förklarade
förhållandet mellan tvärsnittsavkastning och marknadsindexet. Modellen har sedan
generaliserats och genom att beskriva aktieavkastningen som ett linjärt samband mellan
flera faktorer så erhålls bättre förståelse kring den faktiska aktie- och portföljstrukturen.

I denna rapport implementerar och utvärderas en fundamental faktormodell. Målet är att

skapa en dynamisk och robust modell som utgör ett verktyg för portfölj- och
riskanalytiker, med syftet att ge en bättre inblick i vad som driver avkastning samt
förnyar metoder för att analysera riskstrukturen för aktier och portföljer. Genom att
förklara riskstrukturen med hjälp av grundläggande faktorer så ökar förståelsen för
uppbyggnaden av en portfölj. För att lyckas med detta måste faktorernas egenskaper
studeras. Detta görs genom att skapa portföljer som perfekt replikerar företagsspecifika
faktorer, vilka bidrar till förklaringen av aktiers avkastning. Dessa portföljer är härledda
genom tvärsnittsregressioner av aktieavkastningar och aktiers standardiserade
exponering mot faktorer, vilket resulterar i portföljer med önskad exponering. Modellen
som implementerats har utvärderats för både ett europeiskt och svenskt aktieuniversum
och resultaten visar på att vissa faktorportföljer tenderar att ge en överavkastning i
förhållande till marknaden under perioden 2015-01-01 till 2017-01-01.

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iii
Contents
1. Introduction ............................................................................................................................... 1
1.1 Background ......................................................................................................................... 1
1.2 Objective ............................................................................................................................. 2
1.3 Delimitations ....................................................................................................................... 2
1.4 Approach and Outline ......................................................................................................... 2
2. Theory ....................................................................................................................................... 3
2.1 Factor models ...................................................................................................................... 3
2.1.1 Macro-economic factor model ..................................................................................... 3
2.1.2 Statistical factor model ................................................................................................. 5
2.1.3 Fundamental factor model ............................................................................................ 5
2.2 Construction of factor mimicking portfolios ....................................................................... 7
2.2.1 Single factor mimicking portfolios............................................................................... 8
2.2.2 Pure factor mimicking portfolios ............................................................................... 10
2.3 Factor composition ............................................................................................................ 11
2.3.1 Market factor .............................................................................................................. 12
2.3.2 Style factors ................................................................................................................ 12
2.3.3 Industry and country factors ....................................................................................... 16
2.4 Cross-sectional weighted least squares ............................................................................. 17
2.4.1 Principles of Lagrange multiplier method .................................................................. 17
2.4.2 Application of Lagrange multiplier method ............................................................... 19
2.5 Dependence ....................................................................................................................... 21
2.5.1 Covariance.................................................................................................................. 21
2.5.2 Correlation.................................................................................................................. 21
2.5.3 Multicollinearity ......................................................................................................... 22
2.6 Validation .......................................................................................................................... 23
2.6.1 Coefficient of determination ...................................................................................... 23
3. Method .................................................................................................................................... 25
3.1 Data and estimation universes ........................................................................................... 26
3.2 Style factor and industry exposure .................................................................................... 26
3.3 Error handling ................................................................................................................... 27
3.4 Standardization of style factor exposures .......................................................................... 28
3.5 Cross-sectional weighted least squares ............................................................................. 28
3.6 Frequency of rebalancing portfolios ................................................................................. 29
3.7 Validation .......................................................................................................................... 30
4. Results ..................................................................................................................................... 31

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 4.1 Selection of style factors ................................................................................................... 31
4.2 European universe ............................................................................................................. 32
4.3 Swedish universe ............................................................................................................... 39
5. Conclusions ............................................................................................................................. 45
6. Further research ....................................................................................................................... 46
7. References ............................................................................................................................... 47
8. Appendix ................................................................................................................................. 49
8.1 European estimation universe ........................................................................................... 49
8.1.1 Cumulative returns for factor mimicking portfolios with different weighting-schemes
............................................................................................................................................. 49
8.1.2 Cumulative returns for factor different factor mimicking portfolios ......................... 51
8.1.3 Descriptive statistics for the European universe. ....................................................... 53
8.2 Swedish estimation universe ............................................................................................. 54
8.2.1 Cumulative returns for factor different factor mimicking portfolios ......................... 54
8.2.2 Cumulative returns for factor mimicking portfolios with different weighting-schemes
............................................................................................................................................. 56
8.2.3 Descriptive statistics for the Swedish universe .......................................................... 57

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1. Introduction
1.1 Background
The trade-off between securities expected return and their associated risk is an
important objective for portfolio and risk managers, whose purpose is to provide
financial success and sustainability. Because of financial crises and stricter regulatory
framework, managers are in need of robust instruments to interpret risks and enhance
portfolio performance. The capital asset-pricing model (CAPM) formulated by Sharpe
(1964), Lintner (1965), and Black (1972), has long been the dominant instrument to
interpret the risk-return relationship and the cross-sectional return relative to the broad
market index. Since the asset-pricing model was formed, researchers have studied the
trustworthiness of the model and numerous empirical contradictions have been found.

One researcher who developed an alternative to the CAPM was Ross, in the Arbitrage
Pricing Theory (APT). Ross (1976) proved that single factor models should be
generalized to include multiple factors, and thereby created the foundation for multiple
factor models. With multiple factor models, it is more reasonable that factors, which
explain the cross-sectional return, are uncorrelated with the non-diversifiable risk and
thus making the model more accurate. Fama and French (1992) further explored the
topic and concluded that the relation between beta, 𝛽, which is a measure of systematic
risk of a security compared to the market, and the average return in the CAPM is only
positive related in certain periods. Therefore, 𝛽 alone fails to explain the security return.
Instead, Fama and French found empirical evidence that by including the three factors,
book-to-market, market capitalization and 𝛽, the cross-sectional variation in average
stock returns are more accurate explained. Since then, a vast amount of research has
been done in the field to further distinguish factors whom explain securities return.

Analyzing the situation today, multiple factor models have grown in popularity and is
frequently applied in several areas of financial theory. The factors do not only have the
ability to explain the structure of security returns, they also provide portfolio and risk
managers with a framework to categorize securities after economic, statistic and firm
specific attributes (fundamentals). Madhavan (2016) describes how different factors in a
multiple factor model serves as a basis for investments, which is a strategy known as
factor investing or smart-beta. This investing method aims to explain the return
structure of a security through different factors and thereafter find the ones whose return
tend to systematic outperform the market or severely contributes to the risk. To gain
these insights, factor mimicking portfolios are created, which is portfolios whose returns
perfectly replicates those of factors. These portfolios are constructed so that it takes long
positions in securities with high exposure towards a factor, and short positions in
securities with low exposure towards a factor. Thus, by implementing a multiple factor
model and analyzing the factors, portfolio and risk managers will be benefited with
interpretable and robust guidelines to increase portfolio performance and a greater
understanding of risk.

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1.2 Objective
In this paper, we will implement and analyze a fundamental multiple factor model for
equities. The objective is to create a dynamic and efficient program that serves as a tool
to explain the return and risk structures in securities. To achieve this, we will create
portfolios with a weight structure that isolate securities exposure towards firm specific
factors, which thereby replicates the returns of these factors. The analysis will mainly
focus on time series of cumulative returns for these replicating portfolios, in order to
distinguish which factors that tend to perform well and thereby are important for
portfolio performance. To better understand the risk structure of securities, the
relationship between portfolios will also be studied. The models’ credibility and
accuracy will be evaluated through measurements of linear dependence between input
parameters and how this in turn affects the coefficient of determination. Moreover, the
model will be evaluated when changing both security estimation universe and
rebalancing frequency of portfolios. Consequently, we aim to create a robust model that
provides asset and portfolio managers with additional insights of the risk structure of
securities, which thereby hopefully benefits their investors with more attractive products.

1.3 Delimitations
The included factors are selected from existing literature and in agreement with the
supervisors of this project. Furthermore, the common approach of building factors based
on several measurements are excluded in this paper. Instead are single fundamentals
used as factors in the model. Moreover, due to limited access to data are only two equity
universes considered, EURO STOXX 600 and OMXS Stockholm PI. This limitation
also restricts us from including the currency effects, since all securities are listed in the
same currency. Lastly, categorizing securities after corresponding countries are
excluded in this implementation.

1.4 Approach and Outline

In this paper, the characteristics of fundamental factor models will be studied and
implemented. Furthermore, portfolios that perfectly mimic the return of specified equity
fundamentals (factors) will be derived and analyzed throughout the paper. In the second
chapter, the reader will be provided with an overall picture of multiple factor models to
establish understanding of the application area. The continuing section explains the
basic theory behind factor mimicking portfolios, thus how the returns of equity
fundamentals are derived and the construction of factor mimicking portfolios. In the
third chapter, focus is on the implementation of fundamental multiple factor models,
along with a review of necessary steps to replicate the procedure. Thereafter, results
from the model implementation will be presented in the forth chapter, which continues
with a short discussion and conclusion in the final chapter.

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2. Theory

2.1 Factor models

There are several approaches to multiple factor models in financial theory. Although
only the fundamental factor model will be implemented and analyzed, it is important to
understand the difference between multiple factor models. Therefore, this section will
be initiated with a short review of the three most commonly used model and their
advantages and disadvantages respectively. The model approaches are; macro-economic,
statistical and fundamental.

2.1.1 Macro-economic factor model

Connor (1995) describes that a macro-economic multiple factor models aims to explain
the return of a security through a linear combination of macro-economic factors. The
first step of implementing such model is to specify which factors to include. This
decision depends on the investor’s empirical research and available data. For example,
Benakovic et al (2010) analyze how well a macro-economic model can explain the
security return by including the macro-economic factors; price of crude oil on world
market, industrial production index volume index, interest rate, consumer price index,
and stock exchange index. Initially, the change of the selected macro-economic factors
for a given time-period are calculated. This includes calculating the changes in crude oil
prices, consumer price index, industrial production, etc. for a given time-period. Once
these changes are known, one can use them to estimate how exposed securities are
towards changes in macro-economic factors. For example, assume a company’s
operations mainly consists of transportation with vehicles using fossil fuel. If the price
of crude oil on the world market raises, the company’s profitability might decrease and
thereby reducing their stock’s return. Hence, the company’s security return has a
significant exposure to changes in price of crude oil on the world market. To estimate
each securities exposure towards changes in macro-economic factors, a multiple
regression is conducted. The input parameters for the regression is security returns, 𝑟𝑛,𝑡 ,
as dependent variables and changes of macro-economic factors for a given time-period,
𝐶𝑘,𝑡 , as independent variables. Assume that N number of stocks and K macro-economic
factors are included in the model. Then the model is expressed as,
𝐾

𝑟𝑛,𝑡 = 𝛼𝑛 + ∑ 𝑋𝑛,𝑘, 𝐶𝑘,𝑡 + 𝜖𝑛,𝑡 (2.1)

𝑘=1
where

𝑟𝑛,𝑡 = return for security 𝑛 at time t

𝛼𝑛 = constant term
𝑋𝑛,𝑘 = exposure for security 𝑛 to macro-economic factor 𝑘
𝐶𝑘,𝑡 = change of macro-economic factor 𝑘 at time t
𝜖𝑛,𝑡 = disturbance term for security n at time t.

3
The output from the regression of equation (2.1) is the estimated exposure, 𝑋𝑛,𝑘 for each
security n, towards each macro-economic factor k, the constant term, 𝛼𝑛 , for each
security and the disturbance term, 𝜖𝑛,𝑡 , for each security. For example, if the multiple
regression includes 4 stocks and 5 factors, a total of 20 exposures are estimated. The
disturbance term, 𝜖𝑛,𝑡 , has an expected value of zero and constant variance. The
constant term, 𝛼𝑛 , is seldom statistical significant and is therefore usually zero. Once
the estimated exposures and the constant terms are known, a second regression is
performed to estimate the macro-economic factor returns and once again the disturbance
term. The estimated factor returns are also known as risk premiums and can be viewed
as the systematic return of factors. For example, a positive value of a factor return
indicates that investors are being compensated for bearing a positive exposure towards
that factor. The regression is preformed cross-sectional, with the security returns, 𝑟𝑛,𝑡 , as
dependent variable and the estimated exposures, 𝑋𝑛,𝑘 , calculated in the first regression,
as independent variable. A cross-sectional regression, in contrast to time series
regression, means that all data used in the regression represents the same point in time.
Hence, it is cross-sectional over all included securities at time t. The second regression
takes the form

𝑟𝑛,𝑡 = 𝛼𝑛 + ∑ 𝑋𝑛,𝑘, 𝑓𝑘,𝑡 + 𝜖𝑛,𝑡 (2.2)

𝑘=1
where

𝑟𝑛,𝑡 = return for security 𝑛 at time t

𝛼𝑛 = constant term
𝑋𝑛,𝑘 = exposure for security 𝑛 to macro-economic factor 𝑘
𝑓𝑘,𝑡 = factor return of macro-economic factor 𝑘 at time t
𝜖𝑛,𝑡 = disturbance term for security n at time t

Once the factor returns are known, several of statistical tests can be applied to evaluate
the model and if the output parameters from equation (2.1) and (2.2) are statistically
significant. Connor (1995) emphasize the importance of identifying and measure all of
the macro-economic factors affecting security returns. If an investor is uncertain about
the factors affecting the exposures, or the magnitude of these factors, there is a lack of
information to explain security returns. Another disadvantage of macro-economic factor
models is that it requires an extensive set of historical security returns to accurately
estimate exposures and factor returns. In practice, it is occasionally difficult to find long
and stable time series of data for a security’s return. This is particularly the case for
securities on emerging markets or securities that recently been offered to the public.

4
2.1.2 Statistical factor model
A statistical factor model aims to explain the return of a security through statistical
methods, most commonly by the principal component analysis (PCA). As in macro-
economic factor models, the statistical approach aims to assign a value to a factor that
explains the security return. However, a key difference is that the model is strictly
statistical and do not include neither economic nor financial interpretation. Hence,
exposures and factor returns are created in the model only through the security returns,
which is explain more in detail by Bro and Smilde (2014). Alexander (2008) states that
by conducting PCA on a large set of security returns, a smaller number of principal
components can be identified. The principal components are uncorrelated with the
security returns and each principal component explains a proportion of their variation.

The major advantage of using a statistical factor model is that it only requires time
series of security returns. Statistic factor models also have a high explanatory power
since the statistical factors, i.e. principal components, are decided by maximizing the fit
of the model. Although this is desirable properties, it is difficult to interpret what
actions that should be carried out when analyzing the output. As Connor (1995) points
out, a high or low measure in one of the principal components does not contribute to
understanding what factors that explains the return.

2.1.3 Fundamental factor model

The fundamental approach of multiple factor models aims to explain security returns as
linear combinations of fundamentals, industry and country factors. Additionally, a
market factor is included in the model with the purpose to capture the general
fluctuations of markets. The market factor is a source of risk that all securities are
subject to and therefore all securities have a unit exposure towards it. These categories
of factors are discussed in Section 2.3. Alexander (2008) states that a fundamental
factor, also known as style factor, is usually a firm specific attribute. Amongst other,
factors such as firm’s size, sales, volatility, book-to-market value and dividend yield can
be included to explain security returns, since all firms have an exposure towards these
attributes. The reasoning behind factor exposure is similar to the macro-economic
model, although one key difference is that the exposure to fundamental factors do not
have to be estimated through a multiple regression. Hence, a security’s exposure
towards a fundamental factor is known since it is observable and calculated through
fundamental and market data. For example, assume a fundamental factor model
includes the three factors size, book-to-market value and momentum. Consider a
company in the estimation universe that is much larger than the average company. This
company will have a large and positive exposure to the size factor. If the same company
recently have underperformed the average company in the universe, it will also have a
low exposure towards the momentum factor. The industry exposure is usually expressed
with an indicator variable and can either assume the value of 0 or 1, depending on
whether the security can be linked to a certain industry or not. The same procedures
apply for the country exposure.

5
After all firm specific data have been specified, thus securities exposures towards
factors have been calculated, the data have to be standardized. The reason behind this
and how the standardization is performed is clarified in later sections. Thereafter, a
cross-sectional regression is conducted to estimate the factor returns and the disturbance
term. Assume that N is the number of stocks, Kc is the number of countries, Ki is the
number of industries and Ks is the number of fundamental factors. The model can then
be expressed as,
𝐾𝑐 𝐾𝑐+𝐾𝑖 𝐾𝑐+𝐾𝑖+𝐾𝑠

𝑟𝑛,𝑡 − 𝑟𝑓,𝑡 = 𝑓𝑚𝑘𝑡,𝑡 + ∑ 𝑋𝑛,𝑘,𝑡 𝑓𝑘,𝑡 + ∑ 𝑋𝑛,𝑘,𝑡 𝑓𝑘,𝑡 + ∑ 𝑋𝑛,𝑘,𝑡 𝑓𝑘,𝑡 + 𝜖𝑛,𝑡 , (2.3)
𝑘=1 𝑘=𝐾𝑐+1 𝑘=𝐾𝑐+𝐾𝑖+1
where
𝑟𝑛,𝑡 = return for security 𝑛 at time t
𝑟𝑓,𝑡 = periodic return of risk-free rate
𝑓𝑚𝑘𝑡,𝑡 = return of market factor at time t
𝑋𝑛,𝑘,𝑡 = exposure for security 𝑛 to a factor 𝑘 at time 𝑡
𝑓𝑘,𝑡 = factor return to a factor 𝑘 at time 𝑡
𝜖𝑛,𝑡 = disturbance term for security n at time t

In the cross-sectional regression, the security returns over the risk-free rate are used as
dependent variables and the factor exposures are used as the independent variable. The
risk-free rate is subtracted from the security returns because an investor should only be
compensated if the return of a risky security outperforms a risk-free asset. To further
clarify, the known input values before the cross-sectional regression is security’s
exposure towards all factors, security returns and the return of the risk-free rate. The
final output from the cross-sectional regression is the factor returns for each factor
included in the model and the disturbance term, 𝜖𝑛,𝑡 . The disturbance term, 𝜖𝑛,𝑡 , can be
interpret as the return not captured by factors and therefore is the firm specific return.

For example, assume one wants to explain the security return through the factors size,
book-to-market value and momentum in one time-period. Assume that the estimation
universe consists of 3 securities, with firm specific data in time t specified as,

Book-To-
Security 𝑟𝑛,𝑡 − 𝑟𝑓,𝑡 Country Industry Size Market Momentum
Company 1 0.01 Sweden Financial 450 1.1 0.3
Company 2 -0.05 England Industrial 800 0.8 0.1
Company 3 0.02 Sweden Energy 300 2.1 0.2

As mentioned above, the fundamental data, i.e. securities exposure towards size, book-
to-market value and momentum, is observable and have to be standardize before the
cross-sectional regression. For the reader to easier interpret the model, we will express
the explicit form of equation (2.3) before the standardization,

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 0.01 1 1 0 𝑓 1 0 0 𝑓𝐹𝑖𝑛 450 1.1 0.3 𝑓𝑆𝑖𝑧𝑒 𝜖1
𝑆𝑤𝑒
[ −0.05 ] = [ 1 ] 𝑓𝑚𝑘𝑡 + [0 1] [𝑓 ] + [0 1 0 ] [ 𝑓𝐼𝑛𝑑 ] + [800 0.8 0.1] [𝑓𝐵𝑜𝑜𝑘 ] + [𝜖2 ].
0.02 1 1 0 𝐸𝑛𝑔 0 0 1 𝑓𝐸𝑛𝑒 300 2.1 0.2 𝑓𝑀𝑜𝑚 𝜖3

There are several methods that can be applied to estimate the factor returns and the firm
specific return in the equation above. The approach applied in this paper is weighted
least square and Lagrange multiplier, which is further described in Section 2.4. Connor
(1995) states that the firm specific data, i.e. factor exposures, is a key component in the
fundamental model. Therefore, a large and reliable set of data regarding the company’s
fundamentals is required. This causes the model to be data intensive and a numeric
efficient method is preferable upon implementing. Despite these unwanted attributes,
there are several of advantages. The main advantage is that it is possible to interpret the
result once the factor returns have been estimated in the cross-sectional regression. For
example, assume a time series of factor return for the size factor, 𝑓𝑠𝑖𝑧𝑒 , are being
analysed. If analysis reveals that investors tend to be compensated for bearing the size
risk, hence the time series of 𝑓𝑠𝑖𝑧𝑒 is positive, then there may be an opportunity to obtain
excess return by investing in securities with a large and positive exposure towards the
size factor. An additional advantage of this approach is that new securities can be
incorporated to the model very quickly. This is because a cross-sectional regression is
used and thus no historical data for securities are needed. The procedure of creating
portfolios that replicate factor returns are described in the following section.

2.2 Construction of factor mimicking portfolios

As mentioned in the background, the implementation of a fundamental multiple factor
model aims to distinguish the risk-return structure of securities and thereafter find
factors that outperform the market. This leads us to the practice of factor investing, and
more specifically how we can construct portfolios that perfectly replicate the returns of
the factors included in the fundamental factor model. That is, portfolios with a
weighting structure that isolate securities exposure towards firm specific factors, which
thereby replicates the returns of these factors. As we shall see, these portfolios take long
positions in securities with a positive exposure towards a factor and short positions in
securities with negative exposures towards a factor. Factor investing, as this strategy is
called, is also known as smart-beta strategies or risk-premia investing. As mentioned by
Koedijk et al. (2003), the financial research has studied the risk premium of security
returns since the eighties. Research has shown that some investment segments of the
market realize better returns than those in other segments. Well known segments are
stocks with high exposures towards momentum, value, low-volatility and small-size,
and these have been proven by researchers to significantly outperform the market. In
order to understand the concept of factor investing, we start by explaining the
construction of single factor mimicking portfolios, which provides a basis for
construction of pure factor mimicking portfolios and thus the understanding of this
investment strategy. As we shall see, these portfolios are derived through a weighted
least squared method with constraints.

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2.2.1 Single factor mimicking portfolios
Fundamental factor models are often used to create factor mimicking portfolios since
the input data easily can be accessed and is intuitive. This leads to results that also are
possible to interpret for investors, which is a wanted property. These models include
factors such as countries, industries and fundamental factors (called style factors) as
explanatory variables. Additionally, a market factor is often included in the model. The
construction of single factor mimicking portfolios is explained by Menchero (2010) and
Clarke et al. (2017) which both initially emphasize the importance of the
standardization procedure of securities exposure towards factors, i.e. factor exposures,
which is denoted as 𝑋𝑛,𝑘,𝑡 . The style factor exposures require having a weighted mean
of zero,
𝑁
(2.4)
∑ 𝑤𝑛,𝑡 𝑋𝑛,𝑘,𝑡 = 0
𝑛=1
where the security weights, 𝑤𝑛 , are calculated as in equation (2.7) or (2.8) and where N
denotes the number of securities and K denotes the number of factors. Likewise, the
weighted standard deviation should sum to one. Thus,
𝑁
(2.5)
2
∑ 𝑤𝑛,𝑡 𝑋𝑛,𝑘,𝑡 = 1.
𝑛=1
This is applied cross-sectional, i.e. for all securities in the estimation universe at time t.
By implementing this standardization methodology, it can be guaranteed that the
estimated market factor returns are neutralized against all estimated style factor returns,
hence the least squares estimates of style factor returns are expressed relative to the
market factor return due to this weighted standardization. And as we shall see, this
procedure also results in controlling the exposure of a single factor mimicking portfolio.
Menchero (2010) describes the construction of a factor mimicking portfolio for one
single style factor, which is based on a univariate cross-sectional regression of the form,
𝐸
𝑟𝑛,𝑡 = 𝑓𝑚𝑘𝑡,𝑡 + 𝑋𝑛,𝑘,𝑡 𝑓𝑘,𝑡 + 𝜖𝑛,𝑡 (2.6)

𝐸
where 𝑟𝑛,𝑡 denotes the periodic excess return over the risk-free rate, 𝑟𝑓,𝑡−1 Δ𝑡, of the 𝑛th
security. The market factor return are denoted as 𝑓𝑚𝑘𝑡,𝑡 which also is referred to as the
intercept term, since all securities have 100% exposure towards this factor. Furthermore,
𝑓𝑘,𝑡 denotes the return of the kth style factor, 𝑋𝑛,𝑘,𝑡 denotes the exposure to the kth style
factor of the nth security and 𝜖𝑛,𝑡 denotes the idiosyncratic return of the nth security. To
clarify, securities exposures towards factors are known and we aim to estimate the
unknown factor returns, 𝑓𝑘,𝑡 and 𝑓𝑚𝑘𝑡,𝑡 at time t. Notice it is assumed that,

𝑣𝑎𝑟(𝑓𝑘,𝑡 ) = 𝜎𝑓2𝑘
𝑐𝑜𝑣(𝑓𝑘,𝑡 , 𝜖𝑛,𝑡 ) = 0, ∀𝑘, 𝑡
𝑣𝑎𝑟(𝜖𝑛,𝑡 ) = 𝜎𝑛2 , 𝑛 = 1, … 𝑁,

8
and thus the variance of the idiosyncratic term, 𝜖𝑛,𝑡 , is heteroskedastic, i.e. not constant
over time. Therefore, the weighted least squares (WLS) becomes an appropriate and
efficient method for solving the factor returns. However, this suggests that securities
variances are known, since these normally are used as the weighting-scheme for such
regressions. Moreover, a comparable weighting-scheme that is used in this paper are the
square root of market capitalization, since it is proven to be inverted proportional to a
security’s variance. Hence,

√𝑀𝐶𝑛,𝑡
𝑤𝑛,𝑡 = 𝑁 (2.7)
𝛴𝑛=1 √𝑀𝐶𝑛,𝑡

where 𝑀𝐶𝑛,𝑡 denote the market capitalization of the nth security, i.e. a security’s
number of shares multiplied with its price at time t. The weights are standardized so
𝑁
they sum to one over all securities in the estimation universe, hence 𝛴𝑛=1 𝑤𝑛,𝑡 = 1. An
alternatively weighting-scheme that will be considered in this paper is the equally
weighting-scheme. Unlike the market capitalization weighting-scheme, which
distributes weights proportional to the size of securities, the equally weighted-scheme
gives identical weighting to each stock in the universe, resulting in all stocks having the
same impact on factor returns that will be estimated. Thus,
1 (2.8)
𝑤𝑛,𝑡 =
𝑁
where N denotes the total number of securities in the estimation universe. Furthermore,
consider any of the two weighting-schemes (2.7) and (2.8), then single factor returns
can be derived and expressed as,
𝑁
(2.9)
𝑓𝑘,𝑡 = ∑(𝑤𝑛,𝑡 𝑋𝑛,𝑘,𝑡 )𝑟𝐸𝑛,𝑡
𝑛=1

whereas style factor mimicking portfolios are given by 𝑤𝑛,𝑡 𝑋𝑛,𝑘,𝑡 . This can be
interpreted as taking long positions in all stocks with positive exposure towards a given
style factor and short positions in all stocks with negative exposures towards the same
factor. With an accurate standardization procedure, the weights of single style factor
mimicking portfolios sum to zero and have 100% exposure to the given factor as of
equation (2.4) and (2.5) respectively. Moreover, the return of the market factor can be
derived from the regression model (2.6) and is given by,
𝑁
(2.10)
𝑓𝑚𝑘𝑡,𝑡 = ∑ 𝑤𝑛,𝑡 𝑟𝐸𝑛,𝑡
𝑛=1

𝑁
which simply becomes the return of the weighted market portfolio, 𝛴𝑛=1 𝑤𝑛,𝑡 , since the
properties of idiosyncratic returns tend to diversify away, 𝐸[𝜖𝑛,𝑡 ] = 0. Furthermore,
derivation of factor mimicking portfolios including indicator variables such as countries
and industries, differ from how the style factor mimicking portfolios are derived.

9
Consider the regression model defined as in equation (2.6), where 𝑋𝑛,𝐼 ∈ {0, 1} and
now denotes the exposure of the nth security to either industry or country 𝐼. This leads
to a perfect linear dependency between the exposure of the market factor and all
industry factors. This can be interpreted as the market being divided into these different
industries or countries. Consequently, an issue occurs with multicollinearity and the
regression cannot result in a unique solution. In order to manage this issue, Heston and
Rouwenhorst (1994) introduces linear constraints to obtain a unique solution to the
regression model. The most commonly used constraint is that the sum of all weighted
factor returns sum to zero, hence 𝛴𝐼 𝑊𝐼,𝑡 𝑓𝐼,𝑡 = 0. In this case, 𝑊𝐼,𝑡 denote the market
capitalization weights of all stocks included within a specific industry or country. The
market factor return can now be expressed as,
𝐾𝑖 𝑁 (2.11)
𝑤𝑛,𝑡 𝑟𝐸𝑛,𝑡
𝑓𝑚𝑘𝑡,𝑡 = ∑ 𝑊𝐼,𝑡 ∑ ( )
𝑉𝐼,𝑡
𝐼 𝑛∈𝐼

where 𝑉𝐼,𝑡 denote the regression weight of industry or country I. Notice the difference
between equation (2.9) and (2.11) where each indicator variable is market capitalization
weighted, but the stocks within the groups are regression weighted. As a result, the
single industry or country factor returns are given by,

1 𝑁 (2.12)
𝑓𝐼,𝑡 = ( ∑ 𝑤𝑛,𝑡 𝑟𝐸𝑛,𝑡 ) − 𝑓𝑚𝑘𝑡,𝑡
𝑉𝐼,𝑡 𝑛∈𝐼

which can be interpreted as these factor mimicking portfolios going long the indicator
factor mimicking portfolio and goes short the market factor mimicking portfolio defined
in equation (2.11). Thus, industry factor returns are estimated relative to the market, just
as for style factor returns.

2.2.2 Pure factor mimicking portfolios

Unlike the construction of a single factor mimicking portfolios, which is derived
through a univariate cross-sectional regression model, the derivation of pure factor
mimicking portfolios is formed throughout a multivariate cross-sectional regression
model defined as the fundamental model approach. Hence,
𝐾𝑐 𝐾𝑐+𝐾𝑖 𝐾𝑐+𝐾𝑖+𝐾𝑠
𝐸
𝑟𝑛,𝑡 = 𝑓𝑚𝑘𝑡,𝑡 + ∑ 𝑋𝑛,𝑘,𝑡 𝑓𝑘,𝑡 + ∑ 𝑋𝑛,𝑘,𝑡 𝑓𝑘,𝑡 + ∑ 𝑋𝑛,𝑘,𝑡 𝑓𝑘,𝑡 + 𝜖𝑛,𝑡 . (2.13)
𝑘=1 𝑘=𝐾𝑐+1 𝑘=𝐾𝑐+𝐾𝑖+1

That is, by simultaneously processing every country, industry and style factor along
with the market factor. With this approach, we have two exact multicollinearities, that is,
both for the industry and country factors exposures relative to the market factor
exposure. As mentioned before, Heston and Rouwenhorst (1994) manages this issue
with the constraints that the weighted country and industry factor returns sum to zero,
𝛴𝐼 𝑊𝐼,𝑡 𝑓𝐼,𝑡 = 0. This methodology ensures that these factors together do not contribute to

10
the market factor return. The same procedure for standardization of style factor
exposures applies when deriving pure factor mimicking portfolios, which makes them
orthogonal to the market factor and thus calibrates the model so that the return of the
market factor mimicking portfolio is style factor neutral, ∑𝑁 𝑛=1 𝑤𝑛,𝑡 𝑋𝑛,𝑘,𝑡 = 0 . The
factor returns are then estimated using a weighted least squared method with constraints
and the general solution can be expressed as,
𝑁
(2.14)
𝑓𝑘,𝑡 = ∑ 𝛺𝑛,𝑘,𝑡 𝑟𝐸𝑛,𝑡 .
𝑛=1
Where the 𝑛×𝑘 matrix 𝛺𝑛,𝑘,𝑡 , denotes the weight of the nth stock in the kth pure factor
portfolio. Hence, we derive all pure factor mimicking portfolios simultaneously. Since
all factors now are neutralized towards the market factor mimicking portfolio, due to the
standardization procedure and including two linear constraints, the return of the market
factor can be expressed as,
𝑁
(2.15)
𝑅𝑀,𝑡 = 𝑓𝑚𝑘𝑡,𝑡 + ∑ 𝑤𝑛,𝑡 𝜖𝑛,𝑡 .
𝑛=1
Where 𝑤𝑛,𝑡 corresponds to the weight of the nth security in the market portfolio. The
contribution of idiosyncratic returns to the market factor returns are minimal, since the
properties states that, 𝐸[𝜖𝑛,𝑡 ] = 0, 𝐶𝑜𝑣(𝜖𝑛,𝑡 , 𝜖𝑛+1,𝑡 ) = 0 and 𝐶𝑜𝑣(𝜖𝑛,𝑡 , 𝑓𝑛,𝑡 ) = 0. Notice
that this implies that the pure market factor mimicking portfolio is represented by the
𝑁
weighted market portfolio, 𝛴𝑛=1 𝑤𝑛,𝑡 .

So, the main difference between construction single factor mimicking portfolios and
pure factor mimicking portfolios is that we process one factor at the time, which results
in unknown secondary exposure to other factors. In contrast, pure factor mimicking
portfolios have a 100% exposure to one single factor and zero exposure to all other
factors included in the model, since we process all factors simultaneously. The
objectives for portfolio and risk managers using this approach are thus to get an
overview over the risk structure of portfolios, hedge secondary exposure and also make
investment based on certain factors that tend to outperform the market.

2.3 Factor composition

As mentioned as one limitation of this paper, we exclude the step of combining several
risk measurements explaining one single factor exposure due to the scope of this project.
Instead, basic firm specific data are used as factor exposures. For example, the natural
logarithm of market capitalization characterizes the size of a security and are thus used
as a factor exposure towards size.

To reduce the sensitivity of a security’s exposure towards a factor, most factor

exposures are calculated on a 12-month basis of historical data. So, if a security would

11
temporarily report bad figures one quarter, the effect on the factor exposure would not
be that crucial. Hence, a security’s exposure towards a factor are slowly changing with
this methodology. However, this counteracts the advantage of the fundamental factor
model and the cross-sectional regression, because we now need historical data for each
security in the estimation universe, which also makes the implementation even more
data intensive. All style factors used in this implementation have a significant role in
fundamental equity research and will be presented in Section 2.3.2.

Alexander (2008) remarks an alternative approach of creating robust factor exposures

by merging several measurements into one single factor exposure. Consequently, each
factor and its exposure consists of n measurements, where the number of measurements
describing the factor, depends on how much information that is needed to make it robust.
For example, consider securities size as a factor. For example, consider securities size as
a factor. Instead of only using market capitalization to describe the exposure towards
size, one can build a more robust exposure by combining several of measurements
related to size. For example, the natural logarithm of a security’s market capitalization,
total assets and total sales, can be used to better capture the size factor.

To provide a basic summary of this methodology of creating robust factors, a weighting

algorithm is needed in order to merge different measurements into factor exposures.
Before this procedure is applied, each measurement must be standardized to be
comparable with each other. Thereafter, to achieve reasonable weightings between risk
measurements, principal component analysis is often used. Since the first principal
component explains most of the variance in a data set, it is reasonable to use its
coefficients as weights for creating the factor exposure. A complete explanation of this
process for creating security’s exposures towards factors is beyond the scope of this
project.

2.3.1 Market factor

All equities in the estimation universe have a unit exposure to an overall factor, called
the market. This factor corresponds to the well-known phenomena in finance called
undiversifiable risk. In many contexts are changes in interest rates, inflation or events
that affect the broad market return associated with this factor. Intuitively, this factor is
both unpredictable and impossible to completely avoid, thus a source of risk which all
securities in the estimation universe are subject to. Moreover, when considering factor
models where several risk factors are considered, then the market factor is identified as
the net of portfolio exposures to each other factor.

2.3.2 Style factors

Alexander (2008) remarks that a key to succeed with multiple factor models is to
accurately select factors. Faboozzi et al (2010) further states that factors should be
selected throughout economic reasoning in order to be intuitive for investors. The

12
factors must also be measurable and a reliable data set must be available. A common
way to select factors is therefore by analyzing firm’s annual statements and sources of
security market data. However, before adding a factor to the model, it is important to
measure the linear dependency between the existing factor exposures and the new one,
since this could interfere with the least squares estimates. A credible way to measure the
dependency is through Spearman’s rank correlation since the difference between factors
exposures can be significant. The following section will highlight the style factors that
we have chosen to consider in this implementation and also give a short review of how
securities exposure towards these factors are calculated, i.e. the exposure of security n to
a factor k at time t, as well as the economical reasoning behind them.

2.3.2.1 Book-value
The exposure towards book-to-market value at time t for a security is based on 12-
months of the security’s historical data and is given by,
𝐵𝑉12𝑀 (2.16)
𝐵𝑜𝑜𝑘 − 𝑇𝑜 − 𝑀𝑎𝑟𝑘𝑒𝑡𝑡 =
𝑀𝑉𝑡

where 𝐵𝑉12𝑀 denotes the average book-value the last 12 months and 𝑀𝑉𝑡 denotes the
market value at time t. Fama and French (1992) found empirical evidence that there
exists a cross-sectional relation between the book-to-market value and security returns.
The study, which was conducted by analyzing portfolios with different book-to-market
values, showed that securities with high book-to-market value tend to have higher return
than those with a low value. The economic reasoning behind the value factor is that
securities with high book-to-market ratio are more likely to generate excess return than
securities with a low ratio.

2.3.2.2 Momentum
The exposure towards momentum at time t for a security is based on 12-months of the
security’s historical data and is given by,
𝑃𝑡 (2.17)
𝑀𝑜𝑚𝑒𝑛𝑡𝑢𝑚𝑡 =
𝑃𝑇
where 𝑃𝑡 denotes the price today and 𝑃𝑇 denotes the price 12-months ago for a security.
The momentum factor is a measure of a security’s performance and has been recognized
by several researchers. Amongst others, Jegadeesh and Titman (1993) found empirical
evidence of predictability of portfolio returns through momentum. By analyzing past
security prices, they could measure the serial correlation of security market returns,
which is a measure of how well security returns are related to recent performance. A
positive serial correlation means that it is likely for that security to continue to exhibit
positive returns. A negative serial correlation on the other hand, indicates that positive
returns are likely to be followed by negative returns. Jegadeesh and Titman (1993)
further found that significant abnormal returns could be achieved over certain periods
through creating trading strategies which buys securities that have performed well in the
past and sells securities that performed badly. Faboozzi et al (2010) states that the

13
economic reasoning behind the momentum factor is that investors are attracted to stocks
that have performed well in past time periods.

2.3.2.3 Volatility
The exposure towards volatility at time t is derived from time series of historical daily
returns on a 12-months basis for a security. Hence,

(2.18)
𝑑𝑎𝑖𝑙𝑦 Σ𝑇 (𝑟𝑖 − 𝑟̅ )2
𝜎𝑡 = √ 𝑖=1
𝑇−1
where 𝑟𝑖 denotes the daily return and 𝑟̅ denotes the average of daily returns over the past
12-months for a security. Moreover, since the volatility usually is expressed on an
annual basis, we apply the rule of scaling the daily volatility as, √𝑇𝜎𝑡𝑑𝑎𝑖𝑙𝑦 , where T is
assigned a value of 252, corresponding to number of business days annually. Moreover,
applying this rule also assumes that variables are independent and identical distributed
and that logarithmic returns are small and approximately the same as actual returns,
𝑃 𝑃
hence ln (𝑃 𝑡 ) ≈ 𝑃 𝑡 − 1 where 𝑃𝑡 denotes the price. Volatility has for long been an
𝑡−1 𝑡−1

important topic in the security valuation literature and is a measurement of a security’s

price fluctuation for a given time period. One of the pioneers in the topic was
Markowitz (1952) who found that the risk of an individual security can be explained
through the volatility of its returns. An investor should view securities with larger
volatility of returns as riskier and therefore should expect a greater return.

2.3.2.4 Beta
The exposure towards beta at time t for a security is given by,

𝐶𝑜𝑣(𝑅𝑡 , 𝑅𝑟𝑒𝑓,𝑡 ) (2.19)

𝛽𝑡 = 2
𝜎𝑟𝑒𝑓,𝑡

where 𝐶𝑜𝑣(𝑅𝑡 , 𝑅𝑟𝑒𝑓,𝑡 ) denotes the covariance between a security and a reference
2
portfolio at time 𝑡. The 𝜎𝑟𝑒𝑓,𝑡 denotes the variance of the reference portfolio at time 𝑡. In
this paper, two reference portfolios are used, namely the OMXS 30 Index and EURO
STOXX 50 Index. The beta, 𝛽, is one of the most commonly used risk-factors in finance.
It is a measure of systematic risk and usually measures the volatility of a stock relative
to a market as a whole. The economic reasoning behind the beta factor is the same as for
volatility - an investor should view securities with lager beta as riskier and therefore
should expect a greater return.

2.3.2.5 Dividend yield

The exposure towards dividend yield at time t is calculated as the average dividends
over the past 12-months for a security and is divided by the current stock price. Hence,
𝐷𝑖𝑣12𝑀 (2.20)
Dividend yieldt =
𝑃t

14
where 𝑃𝑡 denotes the current stock price at time t and 𝐷𝑖𝑣12𝑀 denote the average annual
dividends per share for a security. Ball (1978) discuss the inefficiencies in markets and
how new information regarding earnings and dividends attracts investors to gain excess
returns. The excess returns tend to exceed the transaction costs and processing costs for
investors acting on this new information, thus making dividend yield a factor that could
capture excess return.

2.3.2.6 Size
The exposure towards size at time t for a security is based on 12-months of the
security’s historical data and are given by,

𝑆𝑖𝑧𝑒𝑡 = ln(𝑆𝑂𝑡 ∗ 𝑃𝑡 ) (2.21)

where 𝑃𝑡 denotes the current stock price at time t and 𝑆𝑂𝑡 denotes the total number of
outstanding shares at time t, for a security. The size factor is found to be strongly related
with returns of a security. Banz (1980) found that securities related to companies with
small market capitalization on average, have higher return than companies with larger
market capitalization. Further analysis also revealed that this is a non-linear relationship
since the difference between adjusted returns for very small companies and large
companies are sufficient, whilst the difference between medium and large companies is
not as significant. This creates an issue with skewness in the distribution between return
and size, which commonly is reduced by the natural logarithm. Faboozzi et al (2010)
states that the economic reasoning behind the size factor is that companies with smaller
market capitalization are likely to outperform larger companies.

2.3.2.7 Share turnover

The exposure towards share turnover at time t is calculated as the natural logarithm of
the sum of daily share turnover during the previous 252 trading days for a security. The
factor is given by the following formula,
252
Vd
Share turnovert = ln (∑ ) (2.22)
Sd
d=1

where 𝑆𝑑 denotes the amount of shares outstanding and 𝑉𝑑 denotes the trading volume
of day 𝑑 over the past 252 days for a security. Several researchers have noted that the
level of liquidity in a security influence its return. For example, Amihud and Mendelsen
(1986) conducted an empirical study where they measured the relationship between
security returns and the security’s bid-ask spread. The results proved that securities with
large difference between the bid and ask price, generally have higher average return.
Chordia, Subrahmanyam, and Anshuman (2001) further explored this subject and
studied the relation between expected security return and fluctuation in liquidity. By
using share turnover as a proxy for liquidity, they found that securities with high
fluctuation generally have lower expected return. In line with previous research, we will
use share turnover as a measure of liquidity and the economic reasoning behind it, is
that investors should expect lower return from securities with high liquidity.
15
2.3.2.8 Sales
The exposure towards sales at time t for a security is based on 12-months of the
security’s historical data and are given by,
𝑆𝑃𝑆3𝑀
𝑆𝑎𝑙𝑒𝑠𝑡 =
𝑃𝑡 (2.23)

where 𝑆𝑃𝑆3𝑀 denotes the current quarterly figures of sales-per-share of a security and is
divided with 𝑃𝑡 which denotes the current stock price at time t for a security. Barebee et
al (1996) argued sales-to-price ratios as being a significant factor describing security
returns. They further argue that this factor may absorb the role of book-to-market as
Fama and French (1992) proved as the best factor to explain security returns.

2.3.2.9 Earnings
The exposure towards earnings at time t for a security is based on 12-months of the
security’s historical data and are given by,
𝐸𝑃𝑆12𝑀
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠𝑡 =
𝑃𝑡 (2.24)

where 𝑃𝑡 denotes the current price of a security and 𝐸𝑃𝑆12𝑀 denotes earnings-per-share
on a 12-month basis for a security. As Jaffe (1989) remarks, there are different
perceptions between financial researchers whether or not earnings-to-price significantly
explains the returns of securities. Some researchers’ states that the size factor accounts
for the effects of earnings yield. A potential bias with this measure is when comparing
figures of a company’s earnings, with stock prices from the same day. These figures are
usually delayed to the public and would thus have a lagged effect on stock prices.

2.3.3 Industry and country factors

King (1966) states that movements of equity returns can be decomposed into market
and industry factors. Lessard (1994) continued to investigate this topic and revealed a
significant relation between securities categorized into countries and equity returns. The
country factors thus tend to be more important in defining groups of securities that share
common return elements. However, as mentioned as one limitation of this paper, we do
not consider the country factors in the implementation.

Moreover, the common practice as described by Burmeister et al (1994) is to categorize

securities into different industries and countries with indicator variables. That is,
variables that either can assume the value of 0 or 1 depending on whether or not the
security can be categorized into a specific country or industry. Another approach is to
denote securities by percentage points, which would give a more ‘true’ model since
large companies tend to be active in several industries and countries. The securities in
this paper are categorized with indicatory variables according to a system provided by
Bloomberg. The classification system consists of the industries Financial, Utilities,
Industrial, Consumer non-cyclical, Basic Material, Technology, Energy,
Communication, Consumer cyclical and Diversified.

16
2.4 Cross-sectional weighted least squares
The weighted least squares (WLS) is a special case of the generalized least squares
(GLS) method, which is applied in this paper due to the heteroskedastic of idiosyncratic
returns. That is, securities variance is not constant over time. Another purpose of using
this methodology is to give weights proportional to securities size, and thus give small
securities less impact on the least squares estimates. This is, because small securities
tend to be much more volatile than larger securities. As we shall see, using WLS in
combination with the Lagrange multiplier (LM) becomes an efficient method for
estimating the factor returns and thus derive the weights of factor mimicking portfolios,
since the method can be adapted for matrix calculations.

2.4.1 Principles of Lagrange multiplier method

Nocedal and Wright (1999) describes that the general purpose with the method is to find
the maximum or minimum of a multivariate function 𝑓(𝑥, 𝑦) which is subject to one or
more multivariate equality constraints 𝑔(𝑥, 𝑦) . In order to explain how the LM
technique works, we first introduce the mathematical formulation of a general
minimizing problem,

𝑔 (𝑥, 𝑦) = 𝑐1 , 𝑖 ∈ 𝔼, (2.25)
min 𝑛 𝑓(𝑥, 𝑦) 𝑠𝑢𝑏𝑗𝑒𝑐𝑡 𝑡𝑜 { 𝑖
{𝑥,𝑦}∈ℝ 𝑔𝑖 (𝑥, 𝑦) ≥ 𝑐2 , 𝑖 ∈ 𝕀,

where both f and g have continuous first partial derivatives, are real-valued functions on
a subset of ℝ𝑛 , and where 𝔼 and 𝕀 are two finite sets of indices. In the formulation
(2.25) of the problem, 𝑓 is denotes the objective function and 𝑔𝑖 , 𝑖 ∈ 𝔼, denotes the
equality constraints and 𝑔𝑖 , 𝑖 ∈ 𝕀, denote the inequality constraints. The feasible set of
possible points (𝑥, 𝑦) that satisfy the constraint and optimize the objective function are
expressed as

Ω = {(𝑥, 𝑦)|𝑔𝑖 (𝑥, 𝑦) = 𝑐1 , 𝑖 ∈ 𝔼; 𝑔𝑖 (𝑥, 𝑦) ≥ 𝑐2 , 𝑖 ∈ 𝕀}, (2.26)

where Ω now is defined on a subset of ℝ𝑛 . Consequently, equation (2.25) can be

rewritten in a more compact way using (2.25)

min 𝑓(𝑥, 𝑦). (2.27)

{𝑥,𝑦}∈Ω

In order to explain the basic principles behind the characterization of solutions of

constrained optimization problems, we work through a simple example. The main idea
using the LM optimization technique is to look for points where the contour lines
(called level curves) of 𝑓 and 𝑔 are tangent to each other. The contour lines are
constructed by letting 𝑓 be equal to some constant 𝑘. Consider the simple example of,

min 𝑥𝑦 𝑠𝑢𝑏𝑗𝑒𝑐𝑡 𝑡𝑜: 𝑥 2 + 𝑦 2 = 1 (2.28)

{𝑥,𝑦}∈ℝ𝑛

then the optimization problem can be illustrated as a geometrical representation shown

in Figures 1-3. The feasible region set by the constraint and the different contour lines
of the objective function can be observed in Figure 1 and 2 respectively.
17
Figure 1 Contour line for the Figure 2 Contour lines for function Figure 3 Illustration of where the
constraint 𝒈(𝒙, 𝒚) = 𝒙𝟐 + 𝒚𝟐 where 𝒇(𝒙, 𝒚) = 𝒙𝒚 for different values of contour lines for 𝒇 and 𝒈 are
𝒄 = 𝟏. 𝒌. tangent.

As can be observed in Figure 3, it is reasonable to assume that there exists a point (𝑥, 𝑦)
in which the contour lines for both functions are tangent to each other. The properties of
gradients suggest that the gradient always is orthogonal for points (𝑥, 𝑦) that coincide
with contour lines. That is, instead of finding the points (𝑥, 𝑦) where both functions are
tangent to each other, it is equivalent to find the points where the gradient vectors of
𝑓 and 𝑔 are parallel to each other. This property is illustrated in Figures 4-6.

Figure 4 - Gradients and contour line Figure 5 - Gradients and contour Figure 6 - Illustration of where the
for constraint 𝒈(𝒙, 𝒚) = 𝒙𝟐 + 𝒚𝟐 lines for function 𝒇(𝒙, 𝒚) = 𝒙𝒚 for contour lines for 𝒇 and 𝒈 are
where 𝒄 = 𝟏. different values of 𝒌. tangent and gradients are parallel
for both functions.

As can be observed in Figure 4-6, the gradients are perpendicular to the contour lines of
both functions. In Figure 3, we can find four different points where the gradients are
parallel to each other and where the two functions are tangent to each other. Hence, we
have four different possible solutions to consider for the optimization problem. The
gradient is a representation of the direction of which the function has the greatest
increase and is defined as vectors containing the partial derivatives of both functions.
Hence,

18
 𝜕𝑓⁄𝜕𝑥 (2.29)
𝛻𝑓(𝑥, 𝑦) = [ ]
𝜕𝑓⁄𝜕𝑦

𝜕𝑔⁄𝜕𝑥 (2.30)
∇𝑔(𝑥, 𝑦) = [ ]
𝜕𝑔⁄𝜕𝑦

Furthermore, the gradients for the two functions are parallel but not necessary of the
same magnitude. Therefore, we introduce a new variable, referred to as the Lagrange
multiplier, 𝜆, the optimization problem can thus be expressed as,

∇𝑓(𝑥, 𝑦) = 𝜆∇𝑔(𝑥, 𝑦) (2.31)

where 𝜆 ∈ ℝ. Equivalent can the optimization problem be expressed as,

ℒ(𝑥, 𝑦, 𝜆) = 𝑓(𝑥, 𝑦) − 𝜆(𝑔(𝑥, 𝑦) − 𝑐) (2.32)

where ℒ is the Lagrange function (called Lagrangian) and where 𝜆 can be either added
or subtracted from the function. Moreover, by noting that ∇ℒ(𝑥, 𝑦, 𝜆) = ∇𝑓(𝑥, 𝑦) −
𝜆∇𝑔(𝑥, 𝑦) we can set the magnitude of the gradient of the Lagrange function to zero,

∇ℒ(𝑥 ∗ , 𝑦 ∗ , 𝜆∗ ) = 𝟎 (2.33)

where 𝟎 represents a vector containing only zeroes. Thus, we are finding the stationary
points (𝑥 ∗ , 𝑦 ∗ , 𝜆∗ ) of the Lagrangian.

2.4.2 Application of Lagrange multiplier method

As noticed by Yan and Su (2009) the methodology of LM is suitable for multiple factor
models since the problem can be rewritten in matrix form and since computers rather
easily and fast can solve linear equation systems as equation (2.33). Consider the
fundamental factor model expressed as in equation (2.3), but now rewritten in matrix
form with 𝑛 assets and 𝑘 factors,

𝐫 = 𝐗𝐟 + 𝛜 (2.34)

where 𝒓 denotes a vector of excess security returns of dimension 𝑛 × 1 and 𝑿 denotes

standardized factor exposures of dimension 𝑛 × 𝑘. Moreover, 𝒇 denotes a vector of
factor returns of dimension 𝑘 × 1 and 𝝐 denotes a vector of idiosyncratic returns for
each security of the dimension 𝑛 × 1. Since we aim to explain as much of the security
returns as possible with k chosen factors, this implies minimizing the sum of squares of
the idiosyncratic returns. Hence, the optimization problem can be expressed as,

min 𝛜T 𝛜 = (𝐫 − 𝐗𝐟)T (𝐫 − 𝐗𝐟). (2.35)

Moreover, as mentioned we consider two weighting-schemes for the derivation of factor

mimicking portfolios, whereas the regression model (2.35) now can expressed using the

19
WLS. That is, we are now minimizing the weighted sum of squares of the idiosyncratic
returns,

min 𝛜𝐓 𝐖𝛜 = (𝐫 − 𝐗𝐟)T 𝑾(𝐫 − 𝐗𝐟) (2.36)

where 𝑾 denotes a diagonal matrix of dimension 𝑛×𝑛 and can be interpreted as the
variances of idiosyncratic returns. Furthermore, when indicator variables are included in
the model, which is often the case, Heston and Rouwenhorst (1994) suggests
introducing linear constraints defined as, 𝛴𝒒𝒇 = 0 . This constraint manages the
problem of multicollinearity. That is, we are letting the factor returns for indicator
variables sum to zero, where 𝒒 denotes a 𝑘×1 vector with the sum of each security’s
weight corresponding to each industry factor and zero for all other factors. At this state
Yan and Su (2009) formulates the Lagrangian as equation (2.32),

ℒ(𝒇, 𝝀) = (𝒓 − 𝑿𝒇)𝑇 𝑾(𝒓 − 𝑿𝒇) + 𝝀𝒒𝒇 (2.37)

where equation (2.35) can be extended to,

ℒ(𝑓, 𝜆) = 𝒓𝑻 𝑾𝒓 − 𝒓𝑻 𝑾𝑿𝒇 − 𝒇𝑻 𝑿𝑻 𝑾𝒓 + 𝒇𝑻 𝑿𝑻 𝑾𝑿𝒇 + 𝜆𝒒𝒇. (2.38)

Furthermore, we derive the gradients of ℒ as in equation (2.29) and (2.30), i.e., the first
order condition with respect to 𝑓 and 𝜆 respectively. The optimization problem can then
be expressed in normal form, 𝑨𝒙 = 𝒃.

𝟐𝑿𝑻 𝑾𝑿𝒇 + 𝜆𝒒 = 𝟐𝑿𝑻 𝑾𝒓 (2.39)

{
𝒒𝒇 = 0

which can be rewritten on the standard blocked matrix form,

𝟐𝑿𝑻 𝑾𝑿 𝒒𝑻 𝒇 𝑻 (2.40)
[ ] [ ] = [𝟐𝑿 𝑾𝒓].
𝒒 0 𝝀 0

Now we can solve the optimization problem by finding the inverse matrix of A in (2.40),
which is the process of finding the matrix B such that 𝑨𝑩 = 𝑩𝑨 = 𝑰, where I denote the
identity matrix. The solution of the problem can be expressed with matrix components
are rather complicated, so to simplify we substitute 𝟐𝑿𝑻 𝑾𝑿 = 𝑨. The inverse matrix
can then be expressed in blocked matrix form,
−1 −1
𝟐𝑿𝑻 𝑾𝑿 𝒒𝑻 𝑨 𝒒𝑻
[ ] =[ ] (2.41)
𝒒 0 𝒒 0
−1 −1 −1
𝑨 𝒒𝑻 𝑨−1 − 𝑨−1 𝒒𝑻 (𝒒𝑨−1 𝒒𝑻 ) 𝒒𝐴−1 𝑨−1 𝒒(𝒒𝑨−1 𝒒𝑻 )
[ ] =[ −1 −1 ]. (2.42)
𝒒 0 (𝒒𝑨−1 𝒒𝑻 ) 𝒒𝑻 𝑨. −1 −(𝒒𝑨−1 𝒒𝑻 )

The least squares estimator, 𝒇, under linear constraints are given by multiplying the
blocked inverse matrix (2.42) on the normal equation (2.40). Hence,
−1
𝒇 = ((𝟐𝑿𝑻 𝑾𝑿)−1 − (𝟐𝑿𝑻 𝑾𝑿)−1 𝒒𝑻 (𝒒(𝟐𝑿𝑻 𝑾𝑿)−1 𝒒𝑻 ) 𝒒(𝟐𝑿𝑻 𝑾𝑿)−1 )𝟐𝑿𝑻 𝑾𝒓 (2.43)

20
Notice that we have derived the implied factor returns and that the factor mimicking
portfolios are given by simply removing 𝒓 from equation (2.43).

2.5 Dependence
In linear regression, knowledge about dependencies between explanatory variables is of
great importance. If the factor model were to include factors with linear dependency, it
could interfere with the estimation of model parameters. In order to explain the issues
associated with linear dependency, we start by defining covariance and correlation.

2.5.1 Covariance
The covariance is a measure of joint variability of two random variables. It is defined as
the expected product of their deviations from their individual expected values. Let
𝑋 and 𝑌 be two random variables, then the covariance is given by,

𝜎𝑋,𝑌 = 𝐶𝑜𝑣(𝑋, 𝑌) = 𝐸[(𝑋 − 𝜇𝑋 )(𝑌 − 𝜇𝑌 )] (2.44)

where 𝜇𝑋 = 𝐸[𝑋] and 𝜇𝑌 = 𝐸[𝑌] are the expected values of X and Y respectively. The
pairwise covariance between several random variables are usually summarized and
presented in matrix form and thus expressed as,

𝜎12 𝜎1,2 𝜎1,3

Σ = [𝜎2,1 𝜎22 𝜎2,3 ] (2.45)
𝜎3,1 𝜎3,2 𝜎32

where the diagonal of the matrix represents the individual random variables variances,
𝑉(𝑋) = 𝐶𝑜𝑣(𝑋, 𝑋) = 𝜎𝑖2 and the 𝜎𝑖,𝑗 denotes the covariance for 𝑖 ≠ 𝑗 . The covariance
matrix must fulfil three conditions; square, symmetric and positive-semi-definite (PSD).
A symmetric matrix means that the upper half should be a mirror image of the lower
half, the matrix should thus be equal when transposed. A square matrix has equally
many numbers of rows and columns and the properties of a PSD matrix states that the
variance in the diagonal is non-negative. A symmetric matrix 𝑴 of dimension 𝑛 × 𝑛, is
PSD if and only if the inequality 𝒛𝑴𝒛𝑇 ≥ 0 holds for all non-zero vectors 𝒛 with
dimensions 1 × 𝑛.

2.5.2 Correlation
The correlation is a measure of linear dependency between random variables, just as the
covariance explained in Section 2.5.1. There exist several techniques for calculating the
correlation between random variables. As we shall see, the Spearman’s rank correlation
is suitable to review whether or not we have multicollinearity between factors exposures.
Since a fundamental factor model includes factor exposures that are somewhat distorted
and incomparable, the Spearman’s rank correlation is a non-parametric test that is more
suitable than Pearson’s correlation coefficient. However, Spearman’s rank correlation is
based on Pearson’s correlation coefficient, which is defined as,
21
 𝐶𝑜𝑣(𝑋, 𝑌) 𝐸[(𝑋 − 𝜇𝑋 )(𝑌 − 𝜇𝑌 )] (2.46)
𝜌𝑋,𝑌 = =
√𝑉(𝑋)𝑉(𝑌) 𝜎𝑋 𝜎𝑌

where 𝐶𝑜𝑣(𝑋, 𝑌) denotes the covariance between the two vectors of random variables 𝑋
and 𝑌 respectively . Furthermore, 𝑉(𝑋) and 𝑉(𝑌) denotes the variances of 𝑋 and 𝑌
respectively. Moreover, Spearman’s rank correlation is closely related to the Pearson’s
correlation coefficient. In order to estimate the Spearman’s rank correlation, we simply
rank (sort) the data for each of the two vectors of random variables before calculating
the Pearson’s correlation as in equation (2.46). Consider a sample of n paired
observations (𝑥1 , 𝑦1 ), … , (𝑥𝑛 , 𝑦𝑛 ), where 𝑅𝑎𝑛𝑘(𝑥𝑖 ) and 𝑅𝑎𝑛𝑘(𝑦𝑖 ) denotes the rank of each
variable. Then the Spearman’s rank correlation coefficient is given by,
𝑛
6Σ𝑖=1 (𝑅𝑎𝑛𝑘(𝑥𝑖 ) − 𝑅𝑎𝑛𝑘(𝑦𝑖 ) )2 (2.47)
𝜌𝑆 = 1 −
𝑛(𝑛2 − 1)

where −1 ≤ 𝜌𝑆 ≤ 1. For example, consider a case with five securities, 𝑠1 , … , 𝑠5 which

have exposures towards two factors, 𝑓1 and 𝑓2 at time t. If one where to analyze the
linear dependence between the two factors to ensure multicollinearity wont be an issue
in the regression, Spearman’s rank correlation can be applied. Assume the five
securities have the following exposures to the two factors,

Security 𝑓1 𝑓2 𝑅𝑓1 𝑅𝑓2 𝑅𝑓1 − 𝑅𝑓2 2

(𝑅𝑓1 − 𝑅𝑓2 )
𝑠1 100.43 28.54 3 4 -1 1
𝑠2 87.12 17.32 1 2 -1 1
𝑠3 105.93 10.05 4 1 3 9
𝑠4 120.01 17.34 5 3 2 4
𝑠5 95.88 31.78 2 5 -3 9
Total 24

where 𝑅𝑓1 and 𝑅𝑓2 denotes the rank of factor 𝑓1 and 𝑓2 respectively. The Spearman’s
rank correlation for the two factor exposures are then given by,

𝑛 2
6Σ𝑖=1 (𝑅𝑓1 − 𝑅𝑓2 ) 6 ∙ 24
𝜌𝑆 = 1 − 2
=1− = 1 − 1.2 = −0.2
𝑛(𝑛 − 1) 5(25 − 1)

which can be interpreted as the factors having a relatively weak negative relationship,
that is, if 𝑓1 increases then 𝑓2 tend to decrease, or vice versa.

2.5.3 Multicollinearity
An issue that often occurs in multiple linear regression analysis, especially regarding
fundamental factor models using time series data, is that of multicollinearity. That is,
when two or more explanatory variables has a high degree of correlation between
themselves. Consequently, this is a problem that can be severe enough to distort the
estimation procedure for the coefficients when using a method such as the OLS. Even
though multicollinearity may affect the precision of the OLS estimators and make it

22
inefficient, the method is still the most efficient of linear unbiased estimators and
therefore also applied in this implementation.

Multicollinearity is an issue that becomes apparent when the estimated coefficients start
to fluctuate when adding additional explanatory variables with linear dependency to
other variables. And as a consequence making it difficult to interpret the result.
Nevertheless, as remarked by Alexander (2008) this is not an ‘all or nothing’ issue,
rather a question of degree. There is no statistical test for the occurrence of
multicollinearity, but rather ‘a rule of thumb’ that if the coefficient of determination of
the regression model, 𝑅 2 , is greater than the pairwise correlation between the
explanatory variables, there is no substantial problem with multicollinearity. The
coefficient of determination, 𝑅 2 , will be explained in a later section. In the situation of
multicollinearity, Alexander (2008) provides some suggestions of procedures to
overcome the problem, e.g. to remove the least significant collinear explanatory
variables of the model, or to replace the data or change the frequency or period of the
data. Yen and Su (2009) provides an additional approach of dealing with this problem,
explicitly by centralizing the data, i.e. subtracting the mean of the original data and use
this in the model instead.

As for now, we have enlightened the problem with linear dependency between any two
variables when dealing with multiple regression analysis in a rather tangible way. Yen
and Su (2008) explains this issue more explicit. Let a regression model be expressed as
𝒓 = 𝑿𝒇 + 𝝐 where 𝑿 is a matrix of dimension 𝑛×𝑘. Then multicollinearity arises if a
column k of the independent variables, 𝑿, has a high degree of correlation to another
one or more columns of 𝑿. In this case, when there exists a linear dependency between
variables, the normal equation of the matrix 𝑿𝑻 𝑿 is ill-conditioned or near singular.
Consequently, the eigenvalues of the matrix may be close to zero and then the
eigenvalues of the inverse matrix (𝑿𝑻 𝑿)−1 tend to be rather large, which may cause
instability of the least squares estimates of the regression parameters. As a result, a
unique solution will be rather unreliable even though it can be calculated.

2.6 Validation
Before making any conclusions from the result of a regression, one should evaluate the
fit of the model. There are several approaches to evaluate the fit of a regression model,
and in statistics the most commonly used is the coefficient of determination, 𝑅 2 and its
adjusted version, 𝑅̅ 2 . As mentioned by Eisenhauer (2003), 𝑅 2 is usually the choice
when using OLS methods, but it is not appropriate to use when implementing a multiple
factor model. The adjusted version, 𝑅̅ 2 , are preferable in this situation and the best
alternative approach to evaluate the fit, as we shall see.

2.6.1 Coefficient of determination

In regression analysis, the coefficient of determination, 𝑅 2 , measures to which extent
the independent variables in the model explains the dependent. Eisenhauer (2003)

23
describes the concept and that it can be interpreted as the proportion of variance
explained by the regression model. 𝑅 2 is calculated as,
𝑁
2
𝑆𝑆𝑅𝑒𝑠 𝛴𝑖=1 (𝜖𝑖 )2 (2.48)
𝑅 =1− =1− 𝑁
𝑆𝑆𝑇𝑜𝑡 𝛴𝑖=1 (𝑟𝑖 − 𝑟̅ )2
where 𝑟 = (𝑟1 , … , 𝑟𝑁 )𝑇 denotes the observed security returns. Moreover, 𝑟̅ denotes the
𝑁 1
average of the observed security returns, 𝑟̅ = 𝑁 𝛴𝑖=1 𝑟𝑖 and 𝜖 denotes a vector of
idiosyncratic returns with dimension 𝑁×1. By definition we have that, 0 ≤ 𝑅 2 ≤ 1, and
a model with 𝑅 2 close to 1 are consider as good and accurate, since the predicted values
are close to the observed ones. However, the coefficient of determination expressed as
in equation (2.48) has some shortcomings. When adding additional explanatory
variables to a model 𝑅 2 tends to increase, this is an unwanted property of such
measurements. This is the reason why it is suggested an adjustment for the number of
explanatory variables relative to the data points in the model. Consequently,
𝑛−1 𝑘 (2.49)
𝑅̅ 2 = 1 − (1 − 𝑅 2 ) = 𝑅 2 − (1 − 𝑅 2 )
𝑛−𝑘−1 𝑛−𝑘−1

where n denotes the number of data points and k denotes the number of explanatory
variables included in the model specification. The measurement, 𝑅̅ 2 , can assign
𝑘
negative values whenever 𝑅 2 < and is by definition defined 𝑅 2 ≥ 𝑅̅ 2 . Ricci (2010)
𝑛−1
explain that 𝑅̅ 2 only increases when an additionally explanatory variable that contributes
more than one could expect by chance. Therefore, this measurement is more appropriate
to use since fundamental factor models usually includes many explanatory variables.

24
3. Method
This section aims to describe the different steps in the process of implementing a
fundamental factor model. Everything from the acquisition of stock specific data to
error handling and calculations of securities factor exposures. Furthermore, we describe
how factor mimicking portfolios are derived as well as its return. A flow chart is
presented in Figure 7, which gives an overview of this process which also will be
described more comprehensively throughout this section.

Figure 7- Flow chart of the different steps of the implementation of a fundamental factor model.

25
3.1 Data and estimation universes
In this implementation, the fundamental model has been evaluated for two different
estimation universes, consisting only of equities. The estimation universes include firm
specific data over the period 2014-01-01 to 2017-01-01. The source used to retrieve this
data is not public and unfortunately cannot be presented in this paper. However, since
the model utilize firm specific data, comparable data can be acquired from official
sources such as corporate financial reports and other public data sources.

OMXS Stockholm PI
This estimation universe is also known as SAX All Share, which is a stock market index
of all shares traded on the Stockholm Stock Exchange. In this implementation we
evaluate the model on a universe that consists of the 200 largest securities based on
market capitalization. The number of securities in this universe varies over time but are
approximately 200 during the estimation window.

EURO STOXX 600 Index

This estimation universe includes 600 securities within Europe, which are distributed
over 11 Eurozone countries. However, in the implementation we only consider 300 of
the largest securities in the index, ordered by market capitalization. The number of
securities studied in this universe also varies over time but are approximately 300
throughout the estimation window.

Notice that all securities within each estimation universe are listed in the same currency.
Consequently, we are not expecting any currency effects and thus do not have to
compensate for this issue when calculating securities exposures towards factors and
when implementing the factor model. Moreover, the risk-free interest rate that is used in
this implementation is the euro overnight index average (EONIA), which is the effective
overnight reference rate for the euro. It is computed as a weighted average of all
overnight unsecured lending transactions in the interbank market of Europe.

3.2 Style factor and industry exposure

The selection of style factors is based on cross-sectional correlation between factor
exposures to avoid linear dependency. For this reason, we will only consider factors
already proven by academic researchers as contributing factors explaining security
returns. Spearman’s rank correlation is calculated over a certain period of time to assess
the level of linear dependency between factor exposures. If high correlation would
appear between any factors, this could lead to linearity within the model and thus affect
the least squares estimates of the regression. This issue is described in theory Section
2.5.3.

26
Initially, we consider nine style factors: size, book-value, momentum, volatility, sales,
dividend yield, share turnover, beta and earnings. Each factor is calculated as described
in theory Section 2.3.2. In addition, a market factor is included in the model and also
industry factors. All securities that are included in the estimation universe are
categorized into one of ten different industry factors, corresponding to the Bloomberg
industry classification system (BICS).

As mentioned, the main purpose of this paper is to implement a fundamental factor

model, but also to investigate how 𝑅̅ 2 and various factor mimicking portfolios are
affected by adding additional factors to the model. Therefore, initially we only include a
few uncorrelated style factors in the model and then by adding additional factors with
and without a high level of linear dependency, we can observe the impact to the model.

3.3 Error handling

Handling incorrect and missing values of firm specific data is a major part of building a
robust and well-functioning factor model. In order to manage this issue, we have chosen
to replace incorrect and missing values with the cross-sectional averages. This approach
is sufficiently fair and will assign a relatively ‘neutral’ value to the specific securities
with either missing or incorrect values.

To exemplify what we mean by ‘neutral’ value, consider the case of a security with
missing data on market capitalization. This data is used to calculate the size factor. If we
were to assign the value of zero to replace the missing value, it would imply that the
security was extremely small. Hence, the security would have zero effect on the
estimation of the size factor and consequently in the construction of the size factor
mimicking portfolio. By assigning the cross-sectional average, the company would get
an average effect which probably is more accurate.

Another case that needs to be managed is when a security is excluded from the
estimation universe. It is an issue that affects the evaluation of factor mimicking
portfolios cumulative returns. We have chosen to assign the excluded securities with
zero in return, since we do not have access to firm specific data when it is excluded
from the estimation universe.

27
3.4 Standardization of style factor exposures
As mentioned in the theory section, the standardize procedure of securities factor
exposures is performed with the purpose of neutralizing the market factor from the other
factors. That is, having zero exposure to the different factors when holding the market
𝑁
portfolio, 𝛴𝑛=1 𝑤𝑛 , but also so that each factor has a variance of 1, when averaging over
every security in the estimation universe. This procedure is essential for deriving factor
mimicking portfolios. The standardization is performed by,
𝑤𝑛 𝑋𝑛,𝑘 − 𝜇𝑘 (3.1)
𝜎𝑘
where 𝑋𝑛,𝑘 denotes the nth security’s exposure towards factor k and 𝑤𝑛 denotes the
weight of the nth security, based on the chosen weighting-scheme. Moreover, 𝜇𝑘
denotes the cross-sectional average of factor exposure k and 𝜎𝑘 denotes the cross-
sectional standard deviation of factor exposure k. In other words, we are adjusting
securities exposures towards factors measured on different scales, into a notionally
common scale to make them comparable. An element larger than |3𝜎𝑘 | is defined as an
outlier, and these values are replaced with either ±3, depending on whether it is a
positive or negative value. The Algorithm 1 is used to achieve the standardized style
factor exposures.

Algorithm 1 – Cross-sectional standardization of securities style factor exposures

1: Let 𝑿 be a matrix of dimension 𝑛×𝑘 containing securities factor exposures, and

W be a diagonal matrix of dimension 𝑛×𝑛 with weights. N denotes number of
securities and K number of factors.
2: Calculate securities weighted exposures towards factors, 𝑾𝑿.
3: Calculate mean 𝜇𝑘 and standard deviation 𝜎𝑘 of securities exposures towards
factor 𝑘.
4: While 𝜇𝑘 ≠ 0 and 𝜎𝑘 ≠ 1 do:
For each element in column k in X, subtract 𝜇𝑘
For each element in column k in X, divided with 𝜎𝑘
If 𝑋𝑛,𝑘 > 3𝜎𝑘
Set 𝑋𝑛,𝑘 = 3.
If 𝑋𝑛,𝑘 < 3𝜎𝑘
Set 𝑋𝑛,𝑘 = −3.
Go to step3
5: Continue for all k columns of X.

3.5 Cross-sectional weighted least squares

Cross-sectional weighted regression is performed with the Lagrange multiplier
methodology, described in theory Section 2.4.2. The aim with this implementation is to
derive pure factor mimicking portfolios, i.e. security weights that create portfolios that

28
perfectly mimic the return of a factor. These factor portfolios have 100% exposure
towards one single factor and zero exposure towards all other factors included in the
model. Consider the weighted optimization problem of minimizing the specific returns,

min 𝝐𝑇 𝑾𝝐 = (𝐫 − 𝐗𝐟)T 𝑾(𝐫 − 𝐗𝐟) (3.2)

where 𝑾 denotes a 𝑛×𝑛 diagonal matrix with security weights. In this implementation
we are evaluating both equally and market capitalization weighting-schemes. The 𝑿
matrix denotes the standardized factor exposures of dimension 𝑛×𝑘 and 𝒓 denotes
the 𝑛×1 column vector with excess returns of securities. The aim is to explain the
excess returns with the factor exposures and thus estimate factor returns, 𝒇 , of
dimensions 𝑘×1 and specific return, 𝝐 of dimension 𝑛×1. This minimization problem
only includes a market factor, a few chosen style factors and ten industry factors.
Consequently, only one constraint is needed to avoid multicollinearity, i.e. 𝛴𝑞𝐼 𝑓 = 0.
The factor returns are derived from equation (2.2) and is given by,
−1
𝒇 = ((𝟐𝑿𝑻 𝑾𝑿)−1 − (𝟐𝑿𝑻 𝑾𝑿)−1 𝒒𝑻 (𝒒(𝟐𝑿𝑻 𝑾𝑿)−1 𝒒𝑻 ) 𝒒(𝟐𝑿𝑻 𝑾𝑿)−1 )𝟐𝑿𝑻 𝑾𝒓 (3.3)

and as we can observe, the factor mimicking portfolios, P, are given by,
−1
𝑷 = ((𝟐𝑿𝑻 𝑾𝑿)−1 − (𝟐𝑿𝑻 𝑾𝑿)−1 𝒒𝑻 (𝒒(𝟐𝑿𝑻 𝑾𝑿)−1 𝒒𝑻 ) 𝒒(𝟐𝑿𝑻 𝑾𝑿)−1 )𝟐𝑿𝑻 𝑾. (3.4)

The Algorithm 2 is implemented in order to calculate the factor mimicking portfolios

and their returns.

Algorithm 2 – Solve minimizing problem using Lagrange multiplier method

1: Calculate diagonal matrix of security weights, 𝑾.

2: Let the minimizing problem be expressed as:
min 𝝐𝑇 𝑾𝝐 = (𝐫 − 𝐗𝐟)T 𝑾(𝐫 − 𝐗𝐟).
3: Create linear constraints for indicator variables, 𝒒𝑰 .
4: Create the Lagrangean function: ℒ(𝒇, 𝝀) = (𝒓 − 𝑿𝒇)𝑇 𝑾(𝒓 − 𝑿𝒇) − 𝝀𝒒𝑰 𝒇
5: Calculate the gradient of ℒ(𝒇, 𝝀) and express the problem on matrix standard
form, 𝑨𝒙 = 𝒃.
6: Calculate the matrix inversion of 𝑨 to obtain factor returns as in equation (3.3)
and (3.4).

3.6 Frequency of rebalancing portfolios

By changing the frequency of rebalancing factor mimicking portfolios, we can study the
effect on cumulative returns. We have chosen to rebalance portfolios every 15, 60 and
120 days over the period 2015-01-01 to 2017-01-01 for both estimation universes.
When rebalancing factor portfolios, the implemented model is calibrated to only

29
consider business days. In the case of a holiday, the nearest business day is chosen for
the calculations.

3.7 Validation
The implemented factor model is evaluated throughout the coefficient of determination,
described in theory Section 2.6.1. We also evaluate the behavior of factor mimicking
portfolio returns when changing the input parameters. We are evaluating the model on
two different estimation universes, for different weighting-schemes and with different
style factors.

30
4. Results
The results presented in this section consider the implementation of a fundamental
factor model, described in Section 3. Selection of style factors, the 𝑅̅ 2 and various factor
mimicking portfolios evolvement through time will be evaluated and presented in this
section. Furthermore, it is studied how different input parameters affect the output of the
implemented model. That is, how cumulative returns of factor mimicking portfolios and
𝑅̅ 2 is affected for following changes:

 adding additional factors (with and without high linear dependency)

 changing frequency of rebalancing factor mimicking portfolios
 changing estimation universe
 applying different weighting-schemes for the regression model

This section is divided into three subsections, selection of style factors, the European
and Swedish estimation universe respectively.

4.1 Selection of style factors

Selection of style factors is based on the level of correlation between cross-sectional
security’s factor exposures. The Spearman’s rank correlation matrix is calculated for the
European estimation universe and presented in Table 1. The correlation fluctuates over
time, and to get a relatively accurate representation of the correlation, an average is
calculated through 12 observations over the period 2015-01-01 to 2017-01-01.
Table 1 - Cross-sectional Spearman’s rank correlation between several factor exposures in the European
estimation universe over the period 2015-2017.

(S) (BV) (M) (V) (SA) (DY) (ST) (B) (E )

Size (S) 1,00
Book Value (BV) -0,01 1,00
Momentum (M) 0,12 -0,37 1,00
Volatility (V) -0,23 0,29 -0,30 1,00
Sales (SA) -0,04 0,47 -0,22 0,30 1,00
Dividend Yield (DY) 0,00 0,57 -0,33 0,20 0,34 1,00
Share turnover (ST) 0,74 0,18 -0,11 0,15 0,14 0,23 1,00
Beta (B) 0,19 0,35 -0,23 0,64 0,30 0,27 0,46 1,00
Earnings (E) 0,04 0,18 -0,05 -0,07 0,12 0,11 0,06 0,05 1,00

As can be seen, there exist a high correlation of 0.74 between the share turnover and
size factor exposures. An additionally high correlation of 0.64 is noticed between the
beta and volatility factor. Since the beta factor cannot be calculated for the Swedish
estimation universe due to missing data, this factor is excluded in further analysis. The
‘standard’ model that is chosen for further analysis includes the size, book-value,
earnings, momentum, and volatility factor respectively. Additionally the sales, dividend
yield and share turnover factors will be added to the model in order to evaluate its
effects on 𝑅̅ 2 and the behavior of factor mimicking portfolios.

31
4.2 European universe
In Figure 8 and 9 𝑅̅ 2 is presented for five different model specifications for the
European estimation universe, with market capitalization and equally weighted
regressions respectively. Both figures illustrate a moving average based on an
estimation window of ten observations, for the period 2015-01-01 to 2017-01-01. The
rebalancing of factor mimicking portfolios and thus the WLS method is computed every
15 days.

R-squared Adjusted
Market capitalization weighted
0,25

0,22

0,19

0,16

0,13

0,1

Standard +Sales +Dividend +Turnover +Sales & Dividend

̅ 𝟐 for different models over European universe on the period 2015-2017.

Figure 8 – Moving average of 𝑹
R-squared Adjusted
Equally weighted
0,35

0,3

0,25

0,2

0,15

0,1

Standard +Sales +Dividend +Turnover +Sales & Dividend

̅ 𝟐 for different models over European universe on the period 2015-2017.

Figure 9 - Moving average of 𝑹

̅ 𝟐 for different weighting-schemes and the standard portfolio plus sales and
Table 2- Descriptive statistic of 𝑹
dividend yield as factors.
Maximum
Minimum
Skewness
Deviation
Standard

Standard

Variance

Kurtosis
Median

Sample

Range
Mean

Error

MC 0,1981 0,0164 0,1861 0,1136 0,0129 1,0517 0,9601 0,5199 0,0399 0,5599
EQ 0,2712 0,0198 0,2652 0,1370 0,0188 0,6555 0,8396 0,6073 0,0949 0,7023

32
Analyzing Figure 8 and 9, 𝑅̅ 2 tend to successively increase when adding additional
factor with low linear dependency. A more comprehensive evaluation of 𝑅̅ 2 for the
standard model plus sales and dividend yield factors, is presented in Table 2. The result
indicates that the equally weighted regression outperforms the market capitalization
weighted regression in explanatory power. This may be due to the fact that the relative
difference between companies in the universe are sovereign. In this case, when the
market capitalization weighting-scheme is applied, a few companies will be assigned a
large proportion of the weight, while smaller companies will be assigned with weights
close to zero. This creates a bad fit for the regression. However, this weighting-scheme
represents the actual market more accurately and due to this fact, further analysis will
therefore mainly focus on the market capitalization weighted regression.

The model that is further analyzed includes the style factors; size, book-value, earnings,
momentum and volatility (referred to as “standard” in figures) since these factors have a
relatively low linear dependency. Additionally to the standard model, sales and dividend
yield are added due to the fact that adding these increased the 𝑅 2 . In addition, the model
includes 10 industry factors and a market factor. Figure 10 and 11 illustrates the
cumulative returns for style factor mimicking portfolios and industry factor mimicking
portfolios respectively.

Cumulative returns for Style factor mimicking portfolios

Market capitalization weighted
0,2

0,15

0,1

0,05

-0,05

-0,1

-0,15

-0,2

Size Book Value Earnings Momentum Volatility Sales Dividend Yield

Figure 10 - Cumulative returns for style factor mimicking portfolios rebalanced every 15 days for the European
universe on the period 2015-2017. Notice that returns are market relative.

33
 Cumulative returns for Industry factor mimicking portfolios
Market capitalization weighted
0,4

0,3

0,2

0,1

-0,1

-0,2

-0,3
Industrial Communications Financial Utilities
Consumer non-cyclical Basic materials Consumer cyclical Technology
Energy Diversified

Figure 11 - Cumulative returns for industry factor mimicking portfolios rebalanced every 15 days for the European
universe on the period 2015-2017. Notice that returns are market relative.

Analyzing Figure 10, several factor mimicking portfolios appear to outperform the
market during the estimation period 2015-01-01 to 2017-01-01. Momentum stands out
with values averaging around 10% above the market. Another factor mimicking
portfolio that indicates excess returns over the market is earnings, whose cumulative
returns also tend to be rather steady over this period. Cumulative returns for industry
factor mimicking portfolios, illustrated in Figure 11, shows tendencies of excess returns
relative the market for technology, consumer cyclical, energy and industrial sectors.
Table 3 - Correlation matrix between factor mimicking portfolio returns derived from market capitalization
weighted regression for the standard model + sales & dividend yield on the period 2015-2017.
Consumer non-cyclical

Consumer cyclical
Communications

Basic materials
Market Factor

Dividend Yield
Momentum

Technology

Diversified
Book Value

Industrial
Volatility

Financial
Earnings

Utilities

Energy
Sales
Size

Ma rket Fa ctor 1,0

Si ze -0,3 1,0
Book Va l ue 0,2 -0,1 1,0
Ea rni ngs 0,0 -0,2 0,1 1,0
Momentum -0,3 -0,5 -0,3 0,1 1,0
Vol a til i ty 0,6 -0,5 0,3 0,0 -0,4 1,0
Sa l es 0,3 0,0 -0,1 0,0 -0,1 0,1 1,0
Di vi dend Yi el d -0,1 -0,2 -0,2 0,0 0,1 0,0 -0,2 1,0
Indus tri a l 0,0 -0,1 0,2 0,1 0,0 0,1 0,1 0,0 1,0
Communi ca tions -0,2 0,0 -0,2 0,1 0,3 -0,2 0,0 0,0 -0,2 1,0
Fi na nci a l 0,3 -0,1 0,2 -0,1 -0,3 0,5 -0,1 -0,2 -0,2 -0,3 1,0
Util i ties -0,2 0,0 -0,3 -0,1 0,1 -0,1 -0,2 0,2 -0,3 0,1 -0,1 1,0
Cons umer non-cycl i ca l 0,1 0,0 0,1 -0,1 0,0 0,0 0,3 -0,1 0,2 -0,2 -0,3 -0,3 1,0
Ba s i c ma teri a l s -0,2 0,1 -0,2 0,0 0,3 -0,4 -0,1 0,2 -0,2 0,1 -0,5 0,0 -0,1 1,0
Cons umer cycl i ca l 0,1 0,0 0,1 0,2 -0,1 -0,1 0,2 0,0 -0,1 -0,1 -0,4 -0,3 0,1 0,0 1,0
Technol ogy -0,2 0,2 -0,1 0,0 -0,1 -0,2 -0,1 0,1 0,1 -0,2 -0,2 0,1 0,1 -0,1 -0,3 1,0
Energy 0,0 -0,1 0,0 0,1 0,1 -0,1 0,2 0,0 0,0 0,0 -0,3 -0,2 0,0 0,1 0,1 -0,2 1,0
Di vers i fi ed -0,1 -0,2 -0,1 0,1 0,2 0,0 -0,1 0,1 0,1 0,1 -0,1 -0,1 0,0 0,0 0,0 -0,1 0,0 1,0

34
The correlation between factor mimicking portfolio returns for the European universe is
presented in Table 3. Analyzing the table, we note that co-movement between factor
mimicking portfolio returns varies a lot. The lowest correlation is -0.5% and found
between several factors. The volatility factor has relatively high correlation with market,
size, momentum, financials and basic materials factors. The highest correlation is 0.6%
and is found between volatility and momentum. The majority of correlations between
factor mimicking portfolio returns are close to zero, although the factor mimicking
portfolio returns between the industries tend to be slightly higher. Knowledge about the
relationship between different factors gives additional insights into what risks a
portfolio is subject to. For example, if the correlation between two portfolios are close
to zero, it may give an investor increased diversification by investing in both these
portfolios. Also, if the correlation is large and negative, an investor might use these
portfolios for hedging purposes.

In Figure 12 and Figure 14 are cumulative returns for both the momentum and size
factor mimicking portfolios presented respectively. Notice that when adding share
turnover to the model, which have high correlation with the size factor, the cumulative
returns for the size factor mimicking portfolio is altered, and this without increasing the
𝑅̅ 2 . The cumulative returns for every factor mimicking portfolio is presented in
Appendix 8.4.1.

35
 Momentum Momentum
0,2 0,15

0,14 0,1

0,08 0,05

0,02 0

-0,04 -0,05

-0,1 -0,1
Standard +Sales
EQ MC
+Dividend +Turnover
+Sales & Dividend

Figure 12 - Cumulative returns for the factor mimicking Figure 13 - Cumulative returns for factor mimicking
portfolio of momentum which is rebalanced every 15 portfolio of momentum with equally and cap-
days for European universe on the period 2015-2017. weighted regressions and “+Sales & Dividend” model.
on the period 2015-2017

Size Size
0,04 0,05

0
0,02

-0,04
-0,01

-0,08
-0,04

-0,12
-0,07

-0,16
Standard +Sales -0,1
+Dividend +Turnover EQ MC
+Sales & Dividend

Figure 14 - Cumulative returns for the factor mimicking

Figure 15 - Cumulative returns for factor mimicking
portfolio of size which is rebalanced every 15 days for
portfolio of size with equally and cap-weighted
European universe on the period 2015-2017.
regressions and “+Sales & Dividend” model on the
period 2015-2017.

Analyzing Figure 13 and 15, the equally weighted regression result in a cumulative
return for factor mimicking portfolios that seem to be less volatile compared to the
market capitalization weighting for the same factors. The effect of changing between
weighting-schemes for all factors is obtained in Appendix 8.1.2.

Another interesting aspect to investigate is the effect of changing the frequency of

rebalancing factor mimicking portfolios. In Appendix 8.1.3 is standard deviation and
average return on daily basis presented together with cumulative returns over the period
2015-01-01 to 2017-01-01. In general, with more frequent rebalancing of factor
mimicking portfolios, we gain a more accurate picture of the true development of a
factor. However, it is difficult to see a clear pattern regarding standard deviation and
average return between different frequencies of rebalancing factor mimicking portfolios.

In Table 4 are the net weights for each industry and the pure market factor mimicking
portfolio for the European estimation universe presented. The pure market factor
mimicking portfolio is 100% net long. Although the net weights for the market factor
mimicking portfolio sum to 1, there is short position in the portfolio as well. As for all
pure industry factor mimicking portfolios, their weights sum to 0 respectively. Note that

36
factor mimicking portfolios are constructed by going long in securities with a high
exposure towards a certain factor and short in stocks with low exposure towards the
same factor, by the same amount of capital. Another thing that can be noticed is that
industry factor mimicking portfolios are 100% long in its own industry and 100% short
in the remaining market factor mimicking portfolio. This is expected after reviewing the
theory section and equation (2.11). For example, the net weight of the industrial factor
mimicking portfolio is 0 in Table 4. Since the industrial companies constitutes of 15.9%
of the total market factor mimicking portfolio, the industrial factor mimicking portfolio
is (100 − 15.9)% = 84.1% long in the industrial companies. The same logic applies to
all industries in the model.

Table 4 – Industry factor mimicking portfolios allocation in different industries derived from a market
capitalization weighted regression.
Communications

Basic materials
non-cyclical

Technology

Diversified
Consumer

Consumer
Industrial

Financial

Utilities

cyclical

Energy
Market 0,159 0,091 0,208 0,062 0,072 0,177 0,136 0,039 0,048 0,007
Financial -0,159 -0,091 0,792 -0,062 -0,072 -0,177 -0,136 -0,039 -0,048 -0,007
Industrial 0,841 -0,091 -0,208 -0,062 -0,072 -0,177 -0,136 -0,039 -0,048 -0,007
Communications -0,159 0,909 -0,208 -0,062 -0,072 -0,177 -0,136 -0,039 -0,048 -0,007
Utilities -0,159 -0,091 -0,208 0,938 -0,072 -0,177 -0,136 -0,039 -0,048 -0,007
Consumer non-cyclical -0,159 -0,091 -0,208 -0,062 0,928 -0,177 -0,136 -0,039 -0,048 -0,007
Basic materials -0,159 -0,091 -0,208 -0,062 -0,072 0,823 -0,136 -0,039 -0,048 -0,007
Consumer cyclical -0,159 -0,091 -0,208 -0,062 -0,072 -0,177 0,864 -0,039 -0,048 -0,007
Technology -0,159 -0,091 -0,208 -0,062 -0,072 -0,177 -0,136 0,961 -0,048 -0,007
Energy -0,159 -0,091 -0,208 -0,062 -0,072 -0,177 -0,136 -0,039 0,952 -0,007
Diversified -0,159 -0,091 -0,208 -0,062 -0,072 -0,177 -0,136 -0,039 -0,048 0,993

37
 Weights for each style factor mimicking portfolio

0,3

0,25
Size
0,2

0,15 Book value

0,1 Earning

0,05 Momentum
0
Volatility
-0,05
Sales
-0,1
Dividend Yield
-0,15
Market
-0,2

-0,25

-0,3

Figure 16 - Style factor mimicking portfolios allocation in different industries derived from a market capitalization
weighted regression.

The industry allocation for style factor mimicking portfolios is presented in Figure 16.
Unlike the industry factor mimicking portfolios, the style factor mimicking portfolios
weights sum to 0, and also have a 0 net weight in each industry. For example, consider
the pure size factor mimicking portfolio. It has been constructed by going long in all
securities with a positive exposure towards size and shorting the securities with a
negative exposure towards the factor, by equal amount. Therefore, it will have a unit
exposure to the size factor and zero exposure to the remaining factors.

38
4.3 Swedish universe
To further analyze the model accuracy and reveal distinctive factors, the same analysis
has been performed on the Swedish estimation universe. As in the analysis of the
European universe, the “standard” model will include the factors size, book-value,
earnings, momentum, and volatility. Similarly, sales, dividend yield and turnover will
successively be added to evaluate 𝑅̅ 2 and the behavior of factor mimicking portfolios.

R-squard Adjusted
Market capitalization weighted
0,15

0,11

0,07

0,03

-0,01

-0,05

Standard +Sales + Dividend Yield + Turnover + Sales + Div

Figure 17 - Moving average of ̅𝟐

𝑹 for different models over Swedish universe on the period 2015-2017.

R-squared Adjusted
Equally weighted
0,3

0,24

0,18

0,12

0,06

0
Standard +Sales + Dividend Yield + Turnover + Sales + Div

̅ 𝟐 for different models over Swedish universe on the period 2015-2017.

Figure 18 - Moving average of 𝑹

39
 ̅ 𝟐 for different weighting-schemes.
Table 5 - Descriptive statistics of 𝑹

Maximum
Minimum
Skewness
Deviation
Standard

Standard

Variance

Kurtosis
Median

Sample

Range
Mean

Error
MC 0,039 0,008 0,031 0,049 0,002 -0,942 0,414 0,164 -0,036 0,128
EQ 0,169 0,007 0,177 0,041 0,002 -1,495 0,043 0,127 0,112 0,239

Figure 17 and 18 illustrates how the various models and weighting-schemes affect 𝑅̅ 2 .
Both figures illustrate a moving average based on an estimation window of ten
observations, for the period 2015-01-01 to 2017-01-01. Rebalancing of factor
mimicking portfolios and thus recalculate of the WLS method is performed every 15
days. A notable difference in the Swedish universe is that the 𝑅̅ 2 does not increase as
significantly when additional factors are added. 𝑅̅ 2 is also generally lower and
especially when market capitalization weighting-scheme is applied to the regression
model. Due to low values and a sequence of negative 𝑅̅ 2 , further analysis will mainly
focus on the models constructed with an equally weighted-scheme. The descriptive
statistics presented in Table 5 further justifies our choice of weighting-scheme.

Cumulative returns for Style factor mimicking portfolios

Equally weighted

0,1

0,05

-0,05

-0,1

-0,15

-0,2

-0,25
Size Book Value Earnings Momentum

Volatility Sales Dividend Yield

Figure 19 - Cumulative returns for style factor mimicking portfolios rebalanced every 15 days for the Swedish
universe using equally weighted regression. The evaluation period is 2015-2017. Notice that returns are market
relative.

Figure 19 illustrates the cumulative returns for style factor mimicking portfolios over
the period 2015-01-01 to 2017-01-01. Analyzing the figure, one can see that momentum
and earnings are factor mimicking portfolios whose cumulative return is highest at the
end of the period. These results are consistent with the market capitalization weighted
scheme in the European estimation universe.

40
 Cumulative returns for Industry factor mimicking portfolios
Equally weighted
0,25

0,05

-0,15

-0,35

-0,55

-0,75
Industrial Communications Financial
Utilities Consumer non-cyclical Basic materials
Consumer cyclical Technology Energy

Figure 20 Cumulative returns for industry factor mimicking portfolios rebalanced every 15 days for the Swedish
universe using equally weighted regression. The evaluation period is 2015-2017. Notice that returns are market
relative.

The cumulative returns for industry factor mimicking portfolios over the period 2015-
01-01 to 2017-01-01 are presented in Figure 20. The result shows that the utilities and
industrial factor mimicking portfolios have outperformed the market over the period.
Remaining industry factor mimicking portfolios seem to keep a similar return as the
market factor mimicking portfolio, with an exception for the consumer-cyclical factor
mimicking portfolio, which has a strongly downward trend in the middle of the
estimation window.

The correlation between factor mimicking portfolio returns for the Swedish estimation
universe are presented in Appendix 8.2.3. The lowest correlation is −0,5 and is found
between both basic materials and book-value and basic material and sales. The highest
correlation is 0,7 between size and market. Comparing the correlation for factor
mimicking portfolios of the Swedish universe, we note that a similar relationship
consists between the factor mimicking portfolio returns in the European universes and
thus no pattern can be found. This information is presented in Appendix 8.2.3 and Table
A3.

41
 Momentum Momentum
0,15 0,2

0,1 0,1

0,05 0

0 -0,1

-0,05 -0,2

-0,3
-0,1
Standard +Sales
+ Dividend Yield + Turnover Equally Market capitalization
+ Sales & Div

Figure 21 - Cumulative returns for the factor mimicking Figure 22 - Cumulative returns for the factor mimicking
portfolio of momentum which is rebalanced every 15 portfolio of momentum with equally and cap-weighted
days for Swedish universe and equally weighted regressions and “+Sales & Dividend” model. Evaluation
regression. Evaluation period 2015-2017. period 2015-2017.

Consumer cyclical Consumer cyclical

0,25 0,15

0,05 -0,03

-0,15 -0,21

-0,35 -0,39

-0,55 -0,57

-0,75 -0,75
Standard +Sales
+ Dividend Yield + Turnover Equally Market capitalization
+ Sales & Div

Figure 23 - Cumulative returns for the factor mimicking Figure 24 - Cumulative returns for the factor mimicking
portfolio of consumer cyclical which is rebalanced portfolio of consumer cyclical with equally and cap-
every 15 days for Swedish universe and equally weighted regressions and “+Sales & Dividend” model.
weighted regression. Evaluation period 2015-2017. Evaluation period 2015-2017.

Figure 21 presents cumulative returns for the momentum factor mimicking portfolio for
different factor model specifications. The factor mimicking portfolios in the figure are
rebalanced every 15 days over the period 2015-01-01 to 2017-01-01 and with the equal
weighting-scheme applied. Analyzing the figure, we note that the spread between the
cumulative returns slightly increase with time. The same pattern is appearing in Figure
23 which illustrates the same information for the consumer cyclical factor. However,
this pattern is not recognized in all factor mimicking portfolios.

Figure 22 and 24 presents cumulative return for momentum and consumer cyclical
factor mimicking portfolios with equally and market capitalization weighting-schemes.
Analyzing Figure 22, the equal weighting-scheme is less volatile than the market
capitalization-scheme and also outperforms the market. However, the opposite relation
is observed for the factor mimicking portfolio of consumer cyclical in Figure 24, which
makes it difficult to determine any kind of pattern. All cumulative returns for factor
mimicking portfolios are presented in Appendix 8.2.1 and 8.2.2.

Standard deviation and average return on daily basis together with cumulative returns
over the period 2015-01-01 to 2017-01-01 is presented in Appendix 8.2.3. As in the
European universe, it is difficult to see any clear patterns. However, since the factor
mimicking portfolios in the Swedish estimation universe is derived through an equally
weighted-scheme, one could expect the standard deviation of cumulative returns to be

42
higher. This is because smaller and thereby generally more volatile securities will be
given larger weights than in the market capitalization regression.

In Appendix 8.2.3 are also the net weights for each industry and the pure market factor
mimicking portfolio for the Swedish estimation universe presented. As noted earlier,
factor mimicking portfolios in this estimation universe is derived through an equally
weighted regression. However, the same framework for the relation between industry
factor mimicking portfolios and the market factor mimicking portfolio applies.

Weights for each style factor mimicking portfolio

0,25

0,2
Size
0,15 Book Value

0,1 Earnings

Momentum
0,05
Volatility
0 Sales

-0,05 Dividend Yield

Market
-0,1

-0,15

Figure 25 –Style factor mimicking portfolios allocation in different industries derived from an equally weighted
regression.

Figure 25 exhibits the pure factor mimicking portfolio weights for style factors in
different industries for the Swedish estimation universe and equally weighted-scheme.
A notable difference from the analysis in the European section is that the market
capitalization weighting-scheme generates weights excess the market factor mimicking
portfolio.

43
Summary of results
In this section we have studied a fundamental multiple factor model on a European and
Swedish estimation universe and evaluated the explanatory power as well as
development of different style, industry and market factor mimicking portfolios.
Initially, factor exposures were evaluated through Spearman’s rank correlation analysis
in order to measure linear dependency. The results revealed a linear dependency
between certain factor exposures, whereas the beta factor was excluded from the model
and further analysis. Both share turnover and dividend yield showed a relatively high
correlation with other factor exposures, whereas their effects on the 𝑅̅ 2 and cumulative
factor mimicking portfolio returns were studied. Share turnover did not add anything to
the explanatory power of the model as expected. Analyzing the results of rebalancing
frequency of factor mimicking portfolios, we find that no consistent relationship
persisted between rebalance frequency and the return-standard-deviation relationship.
However, more frequent rebalancing of portfolios provides more accurate information
which is the true strength of the model. Changing estimation universes and weighting-
schemes provided a sovereign change in both model accuracy and factor mimicking
portfolio performance. The equal weighted-scheme generated a more accurate model in
both estimation universes. Analyzing the factor mimicking portfolio development, we
note that the momentum factor mimicking portfolio was strongest in both universes for
the period being analyzed.

44
5. Conclusions
There are several reasons for building a multiple factor model as a tool for both
portfolio and risk managers. An essential advantage of multiple factor models is that
they provide better insight into what drives the equity return and renews approaches for
analyzing the risk structure of equities. By explaining equity returns through different
factors, it is easier for investors to understand the foundation of a potential portfolio.

The concept of factor investing and factor mimicking portfolios is therefore an

important area to practice and understand. The fundamental multiple factor model
heavily relies on the choice of factors and to carefully select and evaluate these are a
key activity. In this paper, the set of factors evaluated were chosen through existing
literature and in consultation with the supervisors of this project. By analyzing each
factor exposure through Spearman rank’s correlation analysis, the factors could
successively be added to the model without causing problems with collinearity. The
final model consists of a market factor, ten industry factors and the style factors; size,
book-value, earnings, momentum, volatility, sales and dividend yield. The model is
tested against a European and a Swedish universe, where the result shows that some
factor mimicking portfolios yield an excess return relative the market.

Analyzing the choice of weighting-scheme in relation to the coefficient of determination,

we see that it has a sufficient impact on the robustness of the model. In the European
estimation universe, 𝑅̅ 2 averaged approximately 27% for the model with equal
weighted-scheme, whereas the model with market capitalization weighted-scheme
averaged approximately 20%. In the Swedish market, the equivalent numbers for 𝑅̅ 2
were 17% and 4%. The two different weighting-schemes’ also severely affected the
average return and the standard deviation of the factor mimicking portfolios. The
equally weighting-scheme will generally benefit investors with more diversification,
since all companies in a universe will receive the same weights, independent of their
market capitalization. Thus, more weight will be applied to smaller and medium sized
companies. The market capitalization weighting-scheme will more accurately reflect the
‘true’ economy since weights will reflect a company’s actual size. Consequently,
companies with greater market capitalization are given greater weights. There is a risks
associated with this practice, which arises from the fact that fewer and larger companies
will be assigned a great portion of the portfolio weight and thus reduced diversification.

The aim of this paper has been to build a dynamic model that provide asset and
portfolio managers with additional insights of the risk structure of securities and
portfolios. The fundamental factor model for equities provides an understandable way
to communicate investment themes and valuable information. However, as the results
show, the explanatory power is rather low and the implementation needs further
development in order to successively create portfolios that replicate the returns of
specific factors.

45
6. Further research
Since the main focus of this project has been on building a factor model as a dynamic
tool, there has not been enough time to create and test everything wanted. Some
suggestions for continued development of the fundamental factor model implementation
is,

 Create more robust factors. By constructing robust factors, that is, merging
several risk measures into a single factor. If this is implemented, factors
exposures will be less sensitive to changes and thus more robust.
 Adding country and currency factors is another improvement of the factor model
implementation. According to research, the country factors are explaining a
significant amount of security returns.
 Develop a better system to manage incorrect and missing values for securities.
Currently, missing and incorrect values are replaced with the average of the
whole estimation universe, but it would probably be better to replace these
values based only on securities with similar characteristics.
 Forecasting security risk and factor mimicking portfolio returns.

46
7. References
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48
8. Appendix

8.1 European estimation universe

8.1.1 Cumulative returns for factor mimicking portfolios with different weighting-schemes
All figures included in this section is presenting the equally weighted vs market capitalization
weighted regression over the period 2015-01-01 to 2017-01-01 for the standard model + sales
and dividend yields as factors.

Market Size
0,3 0,05

0,2
0

0,1

-0,05
0

-0,1 -0,1
EQ MC EQ MC

Book value Momentum

0,04 0,15

0,02 0,1

0 0,05

-0,02 0

-0,04 -0,05

-0,06 -0,1
EQ MC EQ MC

Volatility Earnings
0,1 0,1

0,05

0 0,05

-0,05

-0,1 0

-0,15

-0,2 -0,05
EQ MC EQ MC

Dividend yield Sales

0,02 0,04

0 0,02

-0,02 0

-0,04 -0,02

-0,06 -0,04
EQ MC EQ MC

Communications Industrial
0,1 0,15

0,05
0,1

0
0,05
-0,05

0
-0,1

-0,15 -0,05
EQ MC EQ MC

49
 Financial Consumer non-cyclical
0,1 0,2

0 0,1

-0,1 0

-0,2 -0,1

-0,3 -0,2
EQ MC EQ MC

Utilities Basic material

0,1 0,15

0,1
0

0,05

-0,1
0

-0,2 -0,05
EQ MC EQ MC

Consumer cyclical Technology

0,15 0,4

0,3
0,1
0,2

0,05 0,1

0
0
-0,1

-0,05 -0,2
EQ MC EQ MC

Energy Diversified
0,3 0,18

0,2
0
0,1

0
-0,18
-0,1

-0,2 -0,36
EQ MC EQ MC

50
8.1.2 Cumulative returns for factor different factor mimicking portfolios
All figures are calculated with the market capitalization weighting-scheme over the
period 2015-01-01 to 2017-01-01. The cumulative factor returns presented in the figures
are rebalanced every 15 days.

Market Size
0,3 0,1

0,22 0,04

0,14 -0,02

0,06 -0,08

-0,02 -0,14

-0,1 -0,2
Standard +Sales Standard +Sales
+Dividend +Turnover +Dividend +Turnover
+Sales & Dividend +Sales & Dividend

Momentum Book value

0,3 0,1

0,22 0,06

0,14 0,02

0,06 -0,02

-0,02 -0,06

-0,1 -0,1
Standard +Sales Standard +Sales
+Dividend +Turnover +Dividend +Turnover
+Sales & Dividend +Sales & Dividend

Earnings Volatility
0,1 0,1

0,06 0,04

0,02 -0,02

-0,02 -0,08

-0,06 -0,14

-0,1 -0,2
Standard +Sales Standard +Sales
+Dividend +Turnover +Dividend +Turnover
+Sales & Dividend +Sales & Dividend

Sales Dividend yield

0,1 0,1

0,06 0,06

0,02 0,02

-0,02 -0,02

-0,06 -0,06

-0,1 -0,1

+Sales +Sales & Dividend +Dividend +Sales & Dividend

Turnover Industrial
0,1 0,14
0,06
0,08
0,02
0,02
-0,02

-0,06 -0,04

-0,1 -0,1
Standard +Sales
+Turnover +Dividend +Turnover
+Sales & Dividend

51
 Communications Utilities
0,1 0,1

0,06 0,04

0,02 -0,02

-0,02 -0,08

-0,06 -0,14

-0,1 -0,2
Standard +Sales Standard +Sales
+Dividend +Turnover +Dividend +Turnover
+Sales & Dividend +Sales & Dividend

Consumer non-cyclical Basic materials

0,15 0,2

0,09 0,14

0,03 0,08

-0,03 0,02

-0,09 -0,04

-0,15 -0,1
Standard +Sales Standard +Sales
+Dividend +Turnover +Dividend +Turnover
+Sales & Dividend +Sales & Dividend

Consumer cyclical Technology

0,2 0,3

0,14 0,22

0,08 0,14

0,02 0,06

-0,04 -0,02

-0,1 -0,1
Standard +Sales Standard +Sales
+Dividend +Turnover +Dividend +Turnover
+Sales & Dividend +Sales & Dividend

Energy Diversified
0,2 0,2

0,14 0,12

0,08 0,04

0,02 -0,04

-0,04 -0,12

-0,1 -0,2
Standard +Sales Standard +Sales
+Dividend +Turnover +Dividend +Turnover
+Sales & Dividend +Sales & Dividend

52
8.1.3 Descriptive statistics for the European universe.
Table A1 – Comparison of standard deviation, average return and cumulative return for factors when using
different frequencies of rebalancing portfolios. The evaluation period is 2015-2017

Standard deviation(daily) Average return(daily) Cumulative return(2 years)

15 60 120 15 60 120 15 60 120
Market 1,20% 1,16% 1,10% 0,05% 0,05% 0,05% 25,50% 23,80% 23,83%
Size 0,58% 0,63% 0,62% 0,00% 0,00% 0,00% 1,93% -0,26% -0,85%
Book Value 0,22% 0,23% 0,24% 0,00% 0,00% 0,00% 0,07% 0,64% 0,27%
Earnings 0,13% 0,13% 0,13% 0,01% 0,01% 0,01% 5,47% 4,49% 5,50%
Momentum 0,58% 0,56% 0,51% 0,01% 0,01% 0,01% 3,85% 3,96% 5,07%
Volatility 0,53% 0,53% 0,54% -0,02% -0,01% -0,01% -8,12% -4,89% -5,91%
Sales 0,16% 0,16% 0,17% 0,00% 0,00% 0,00% 0,09% 0,31% 0,50%
Dividend Yield 0,17% 0,16% 0,17% -0,01% -0,01% -0,01% -3,24% -3,20% -3,09%
Industrial 0,32% 0,31% 0,30% 0,02% 0,02% 0,02% 9,86% 10,05% 10,63%
Communications 0,42% 0,40% 0,40% -0,02% -0,02% -0,02% -8,53% -10,14% -10,92%
Financial 0,48% 0,47% 0,49% -0,03% -0,03% -0,03% -16,05% -14,63% -13,39%
Utilities 0,64% 0,63% 0,61% -0,03% -0,02% -0,02% -15,44% -10,65% -11,07%
Consumer non-cyclical 0,53% 0,54% 0,53% 0,01% 0,01% 0,01% 7,20% 6,49% 6,84%
Basic materials 0,34% 0,32% 0,32% 0,00% 0,00% 0,00% 1,61% 1,96% 0,69%
Consumer cyclical 0,47% 0,46% 0,45% 0,02% 0,01% 0,01% 10,21% 7,38% 5,86%
Technology 0,92% 0,92% 0,92% 0,06% 0,06% 0,06% 30,45% 28,21% 31,29%
Energy 0,58% 0,58% 0,57% 0,03% 0,03% 0,03% 15,51% 14,03% 15,42%
Diversified 0,74% 0,77% 0,80% -0,01% -0,02% -0,01% -7,35% -8,97% -6,10%

53
8.2 Swedish estimation universe
8.2.1 Cumulative returns for factor different factor mimicking portfolios
All figures are calculated with the market capitalization weighting-scheme over the
period 2015-01-01 to 2017-01-01. The cumulative factor returns presented in the figures
are rebalanced every 15 days.

0,5
Market 0
Size
0,4 -0,05

0,3 -0,1

0,2 -0,15

0,1 -0,2

0 -0,25
Standard +Sales Standard +Sales
+ Dividend Yield + Turnover + Dividend Yield + Turnover
+ Sales + Div + Sales + Div

0,1
Book Value Earnings
0,1
0,06
0,04
0,02 -0,02
-0,02 -0,08
-0,06 -0,14

-0,1 -0,2
Standard +Sales Standard +Sales
+ Dividend Yield + Turnover + Dividend Yield + Turnover
+ Sales + Div + Sales + Div

0,2
Momentum 0,1
Volatility
0,12 0,06

0,04 0,02

-0,04 -0,02

-0,12 -0,06

-0,2 -0,1
Standard +Sales Standard +Sales
+ Dividend Yield + Turnover + Dividend Yield + Turnover
+ Sales & Div + Sales + Div

Industrial Communications
0,2 0,03
0,15
0
0,1
-0,03
0,05
-0,06
0
-0,09
-0,05
-0,1 -0,12
Standard +Sales Standard +Sales
+ Dividend Yield + Turnover + Dividend Yield + Turnover
+ Sales + Div + Sales + Div

54
 0,1
Financial 0,2
Utilities
0,06 0,12

0,02 0,04

-0,02 -0,04

-0,06 -0,12

-0,1 -0,2
Standard +Sales Standard +Sales
+ Dividend Yield + Turnover + Dividend Yield + Turnover
+ Sales + Div + Sales + Div

Consumer non-cyclical Consumer cyclical

0,08 0,1

0,04 -0,06

0 -0,22

-0,04 -0,38

-0,08 -0,54

-0,12 -0,7
Standard +Sales Standard +Sales
+ Dividend Yield + Turnover + Dividend Yield + Turnover
+ Sales + Div + Sales & Div

0,15
Basic materials 0,1
Technology
0,1 0,06

0,05 0,02

0 -0,02

-0,05 -0,06

-0,1 -0,1
Standard +Sales Standard +Sales
+ Dividend Yield + Turnover + Dividend Yield + Turnover
+ Sales + Div + Sales + Div

0,2
Energy
0,12

0,04

-0,04

-0,12

-0,2
Standard +Sales
+ Dividend Yield + Turnover
+ Sales + Div

55
8.2.2 Cumulative returns for factor mimicking portfolios with different weighting-schemes
All figures included in this section is presenting the equally weighted vs market
capitalization weighted regression over the period 2015-01-01 to 2017-01-01 for the
standard model + sales and dividend yields as factors.

0,5
Market 0,25
Size
0,4 0,15

0,3 0,05

0,2 -0,05

0,1 -0,15

0 -0,25

Equally Market capitalization Equally Market capitalization

0,15
Momentum Earnings
0,14
0,07 0,1
-0,01 0,06
-0,09 0,02
-0,17 -0,02

-0,25 -0,06

Equally Market capitalization Equally Market capitalization

Book Value Financial

0,1 0,1

0,06 0,06

0,02 0,02

-0,02 -0,02

-0,06 -0,06

-0,1 -0,1

Equally Market capitalization Equally Market capitalization

Communication
Industrial
0,18 0,1

0,14 0,06

0,1 0,02

0,06 -0,02

0,02 -0,06

-0,02 -0,1

Equally Market capitalization Equally Market capitalization

Utilities
0,25
Volatility
0,07
0,15

0,05 0,02

-0,05
-0,03
-0,15

-0,25 -0,08

Equally Market capitalization Equally Market capitalization

56
 Consumer non-cyclical Technology
0,05 0,15
-0,03 0,1
-0,11 0,05
-0,19 0
-0,27 -0,05
-0,35 -0,1

Equally Market capitalization Equally Market capitalization

0,2
Consumer cyclical 0,1
Basic Material
0 0,06

-0,2 0,02

-0,4 -0,02

-0,6 -0,06

-0,8 -0,1

Equally Market capitalization Equally Market capitalization

Consumer cyclical Energy

0,2 0,16

0 0,12

-0,2 0,08

-0,4 0,04

-0,6 0

-0,8 -0,04

Equally Market capitalization Equally Market capitalization

8.2.3 Descriptive statistics for the Swedish universe

Table A3 - Correlation between factor returns derived from equally weighted regression and the standard model
+ sales & dividend yield. The period considered is 2015-2017.
Consumer non-cyclical

Consumer cyclical
Communications

Basic materials
Dividend Yield
Momentum

Technology
Book Value

Industrial

Financial
Volatility
Earnings
Market

Utilities

Energy
Sales
Size

Market 1,0
Size 0,7 1,0
Book Value 0,0 -0,1 1,0
Earnings -0,1 -0,1 -0,1 1,0
Momentum 0,1 0,1 0,2 0,0 1,0
Volatility 0,3 0,3 0,1 -0,2 0,2 1,0
Sales 0,1 0,3 -0,5 0,1 0,1 0,0 1,0
Dividend Yield 0,2 0,0 0,2 -0,2 0,1 0,4 -0,2 1,0
Industrial 0,0 0,0 0,3 0,0 0,2 0,1 -0,3 0,1 1,0
Communications 0,0 0,0 0,3 0,0 0,1 0,1 -0,2 0,1 0,1 1,0
Financial -0,1 -0,1 0,3 0,1 -0,1 -0,2 -0,2 0,0 -0,1 0,0 1,0
Utilities 0,1 -0,1 0,0 -0,1 -0,2 0,1 -0,2 0,0 -0,1 -0,2 -0,3 1,0
Consumer non-cyclical -0,1 0,0 0,0 0,0 0,1 0,0 0,0 -0,2 -0,2 -0,1 -0,1 -0,2 1,0
Basic materials 0,0 0,0 -0,5 0,0 0,0 0,0 0,5 0,0 -0,3 -0,3 -0,4 -0,2 -0,1 1,0
Consumer cyclical 0,2 0,3 -0,4 0,0 0,0 0,0 0,4 0,0 -0,3 -0,3 -0,2 0,1 -0,1 0,1 1,0
Technology -0,1 0,1 0,0 0,0 -0,1 -0,1 -0,1 -0,1 -0,1 -0,1 0,0 -0,2 -0,1 -0,2 0,0 1,0
Energy -0,1 0,0 -0,2 0,1 -0,1 -0,1 0,1 -0,1 0,0 -0,1 -0,1 0,0 -0,1 0,2 -0,1 -0,1 1,0

57
Table A4 – Comparison of standard deviation, average return and cumulative return for factors when using
different frequencies of rebalancing portfolios. The evaluation period is 2015-2017.

Standard deviation (daily) Average return (daily) Cumulative return (2 years)

15 60 120 15 60 120 15 60 120
Market 0,83% 0,82% 0,80% 0,09% 0,09% 0,09% 43,41% 42,68% 44,22%
Size 0,38% 0,40% 0,40% -0,04% -0,04% -0,04% -19,01% -18,12% -18,50%
Book Value 0,32% 0,32% 0,31% 0,00% 0,00% 0,00% 1,04% -1,68% -2,45%
Earnings 0,26% 0,26% 0,27% 0,02% 0,01% 0,03% 8,46% 5,50% 13,16%
Momentum 0,25% 0,25% 0,24% 0,02% 0,02% 0,01% 7,52% 8,76% 6,57%
Volatility 0,38% 0,39% 0,38% 0,00% 0,00% 0,00% 0,28% -1,39% -2,44%
Sales 0,32% 0,32% 0,27% -0,03% -0,03% -0,02% -13,00% -13,15% -7,89%
Dividend Yield 0,18% 0,18% 0,18% 0,00% 0,00% 0,00% 1,05% -1,04% -1,23%
Industrial 0,31% 0,31% 0,31% 0,03% 0,02% 0,02% 12,61% 11,89% 10,88%
Communications 0,38% 0,37% 0,36% 0,00% 0,00% -0,01% 0,17% -1,07% -2,89%
Financial 0,38% 0,39% 0,38% 0,00% -0,01% 0,00% -0,83% -2,94% -1,95%
Utilities 0,87% 0,87% 0,88% 0,03% 0,04% 0,04% 15,75% 19,64% 17,86%
Consumer non-cyclical 0,55% 0,54% 0,53% -0,02% -0,01% -0,02% -8,90% -6,40% -7,64%
Basic materials 0,49% 0,49% 0,47% -0,02% -0,01% -0,01% -7,52% -5,66% -4,27%
Consumer cyclical 1,63% 1,70% 1,70% -0,10% -0,09% -0,08% -47,94% -44,95% -41,15%
Technology 0,57% 0,57% 0,55% -0,01% -0,01% -0,01% -3,23% -3,62% -2,67%
Energy 0,68% 0,73% 0,71% 0,00% -0,01% -0,01% 1,19% -4,19% -3,12%

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Table A5 - Industry factor portfolios allocation in different industries derived from an equally weighted regression.
Evaluation period 2015-2017.

Communications

Basic materials
non-cyclical

Technology
Consumer

Consumer
Industrial

Financial

Utilities

cyclical

Energy
Market 0,208 0,130 0,205 0,068 0,091 0,172 0,029 0,075 0,023
Financial -0,208 -0,130 0,795 -0,068 -0,091 -0,172 -0,029 -0,075 -0,023
Industrial 0,792 -0,130 -0,205 -0,068 -0,091 -0,172 -0,029 -0,075 -0,023
Communications -0,208 0,870 -0,205 -0,068 -0,091 -0,172 -0,029 -0,075 -0,023
Utilities -0,208 -0,130 -0,205 0,932 -0,091 -0,172 -0,029 -0,075 -0,023
Consumer non-cyclical -0,208 -0,130 -0,205 -0,068 0,909 -0,172 -0,029 -0,075 -0,023
Basic materials -0,208 -0,130 -0,205 -0,068 -0,091 0,828 -0,029 -0,075 -0,023
Consumer cyclical -0,208 -0,130 -0,205 -0,068 -0,091 -0,172 0,971 -0,075 -0,023
Technology -0,208 -0,130 -0,205 -0,068 -0,091 -0,172 -0,029 0,925 -0,023
Energy -0,208 -0,130 -0,205 -0,068 -0,091 -0,172 -0,029 -0,075 0,977

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