A generic framework for monetary performance attribution

We propose a generic framework for performance attribution in monetary terms. Through a second-order Taylor approximation, the changes in portfolio value are attributed to a set of systematic risk factors. By considering two error terms arising from the Taylor approximation, combined with an exact definition of the carry term, we derive a residual-free performance attribution framework, where we exert control over the size of the error terms. The framework incorporates foreign exchange rates and transaction costs, which is illustrated by simulating a European investor acting on the U.S. fixed income market. For the out-of-sample period, we show that we can attribute almost all portfolio value differences and variance using six risk factors obtained from principal component analysis. The results show that our method, in combination with high-quality estimates of risk factors, outperforms other fixed-income attribution models from the literature.