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Combining Alphas via Bounded Regression

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  • Zura Kakushadze

    () (Quantigic® Solutions LLC, 1127 High Ridge Road #135, Stamford, CT 06905, USA
    Business School & School of Physics, Free University of Tbilisi, 240, David Agmashenebeli Alley, Tbilisi 0159, Georgia)

Abstract

We give an explicit algorithm and source code for combining alpha streams via bounded regression. In practical applications, typically, there is insufficient history to compute a sample covariance matrix (SCM) for a large number of alphas. To compute alpha allocation weights, one then resorts to (weighted) regression over SCM principal components. Regression often produces alpha weights with insufficient diversification and/or skewed distribution against, e.g., turnover. This can be rectified by imposing bounds on alpha weights within the regression procedure. Bounded regression can also be applied to stock and other asset portfolio construction. We discuss illustrative examples.

Suggested Citation

  • Zura Kakushadze, 2015. "Combining Alphas via Bounded Regression," Risks, MDPI, Open Access Journal, vol. 3(4), pages 1-17, November.
  • Handle: RePEc:gam:jrisks:v:3:y:2015:i:4:p:474-490:d:58313
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    References listed on IDEAS

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    1. repec:pal:assmgt:v:18:y:2017:i:1:d:10.1057_s41260-016-0004-9 is not listed on IDEAS

    More about this item

    Keywords

    hedge fund; alpha stream; alpha weights; portfolio turnover; investment allocation; weighted regression; diversification; bounds; optimization; factor models;

    JEL classification:

    • C - Mathematical and Quantitative Methods
    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance
    • M2 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting
    • K2 - Law and Economics - - Regulation and Business Law

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