Measuring and managing market, credit and Op risk [108]

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Bullet points include: A common way of deriving factors describing observed market behaviour Typically introduced via eigenvalues and (normalised) eigenvectors of the return covariance matrix, V i.e. solutions to Vx = lambda x; the lambda are the eigenvalues, the x are the eigenvectors Any instrument’s behaviour then expressible as a linear combination of ‘signals’ associated with these eigenvectors i.e. r(j, t) = a(j,1) .S1(t) + a(j,2).S2(t) + ... + a(j,n).Sn(t)   for instrument j Eigenvectors are orthogonal, deemed to be ‘different ’ drivers of behaviour Usually limit merely to ‘significant’ factors, and add back idiosyncratic risk

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