Anon

306 The Basics of financial economeTrics

In Chapters 3 and 4, we explained how to build, diagnose, and test a
multiple linear regression model. In this chapter, we provide a blueprint as to
how to apply financial econometrics to quantitative asset management. The
objective of quantitative asset management is to identify any persistent pat-
tern in financial data and convert that information into implementable and
profitable investment strategies. We discuss the general process for converting
statistical information obtained from the application of financial economet-
ric tools into implementable investment strategies that can be employed by
asset managers. Generally, this process includes developing underlying finan-
cial theories, explaining actual asset returns, and estimating expected asset
returns that can be used in constructing a portfolio or a trading position. In
addition, we identify some of the commonly induced biases in this process.
In Figure 15.1, we provide a flowchart that shows the process of how
quantitative research is performed and converted into implementable

Quantitative Research

Develop an Ex Ante Hypothesis

Select a Survivorship-Free Sample

Select a Methodology to Estimate

the Model

No Yes

Investment Strategy

Estimate Expected Returns

No Yes

No Yes

Independent Risk Control

FIgUre 15.1 Process of Quantitative Research and Investment Strategy