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How to Construct a Stock Selection Strategy: Multi-Factor Analysis

In: Quantitative Investing

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  • Lingjie Ma

    (University of Illinois at Chicago)

Abstract

In this chapter, we introduce stock selection strategies and demonstrate how to employ a multi-factor model to build alphas for such a strategy. How can we forecast stock returns? To answer this critical question, we first discuss market inefficiency and identify sources of return anomalies. We then show how to transform these fundamental sources into a multi-factor alpha model. Regarding related finance theory, we introduce the capital asset pricing model (CAPM). On the quantitative side, we present the ordinary least squares (OLS) method. We explore estimation, inference, and properties and conditions of OLS estimates. Regarding industry insights, we show, using the Russell 1000 security level data, how to construct a multi-factor alpha model for a large-cap core stock selection portfolio. For R programming, we introduce commonly used utility functions in quantitative investing.

Suggested Citation

  • Lingjie Ma, 2020. "How to Construct a Stock Selection Strategy: Multi-Factor Analysis," Springer Books, in: Quantitative Investing, chapter 0, pages 111-179, Springer.
    • Handle: RePEc:spr:sprchp:978-3-030-47202-3_4
    DOI: 10.1007/978-3-030-47202-3_4
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