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How to build a factor portfolio: Does the allocation strategy matter?
Author(s) -
Dichtl Hubert,
Drobetz Wolfgang,
Wendt ViktoriaSophie
Publication year - 2021
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/eufm.12264
Subject(s) - asset allocation , portfolio , factor (programming language) , investment (military) , investment strategy , portfolio allocation , economics , risk premium , capital allocation line , computer science , project portfolio management , microeconomics , black–litterman model , portfolio optimization , econometrics , financial economics , replicating portfolio , project management , profit (economics) , management , politics , political science , law , programming language
Factor‐based allocation embraces the idea of factors, as opposed to asset classes, as the ultimate building blocks of investment portfolios. We examine whether there is a superior way of combining factors in a portfolio and provide a comparison of factor‐based allocation strategies within a multiple testing framework. Factor‐based allocation is profitable beyond exploiting genuine risk premia, even when applying multiple testing corrections. Investment portfolios can be efficiently diversified using factor‐based allocation strategies, as demonstrated by robust economic performance over various economic scenarios. The naïve equally weighted factor portfolio, albeit simple and cost‐efficient, cannot be outperformed by more sophisticated allocation strategies.