The Risk of Choosing the Wrong Factors


The Risk of Choosing the Wrong Factors

Damian Handzy, Ph.D.

When it comes to equity investing, how do people choose what makes for a good factor? Why do people use factors in the first place? Unlike the bond markets or derivatives markets, equities have no valuation formula to determine if a stock is mispriced by the market. Where bonds have discounted cash flows of known coupon and principal payments, and where options have pricing formulas like Black-Scholes, stocks have no theoretical framework by which to estimate if they are over- or under-valued.

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