Market Risk [35]

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Bullet points include: A common way of deriving factors that describe 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 to ‘significant’ factors, and add back idiosyncratic risk

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