{"id":831608,"date":"2020-08-16T06:30:49","date_gmt":"2020-08-16T06:30:49","guid":{"rendered":"https:\/\/stockviz.biz\/index.php\/2020\/08\/16\/factors-intro\/"},"modified":"2021-09-14T08:43:36","modified_gmt":"2021-09-14T03:13:36","slug":"factors-intro","status":"publish","type":"post","link":"https:\/\/stockviz.biz\/index.php\/2020\/08\/16\/factors-intro\/","title":{"rendered":"Factors, Intro"},"content":{"rendered":"\n

First came the market, then came the factors…<\/h2>\n\n\n\n

The Efficient Market Hypothesis<\/h2>\n\n\n\n

Two economists walk down a road and they see a twenty dollar bill lying on the side-walk. One of them asks \u201cis that a twenty dollar bill?\u201d Then the other one answers \u201cIt can\u2019t be, because someone would have picked it up already,\u201d and they keep walking. (source<\/a>)<\/p><\/blockquote>\n\n\n\n

In 1965, Eugene Fama published his dissertation arguing for the random walk hypothesis. i.e., stock market prices evolve according to a random walk (so price changes are random) and thus cannot be predicted. This was followed by Paul Samuelson, who published a proof showing that if the market is efficient, prices will exhibit random-walk behavior. (source<\/a>) <\/p>\n\n\n\n

Together, they form the basis of the efficient market hypothesis (EMH).<\/p>\n\n\n\n

The efficient market hypothesis (EMH), is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible. According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices. Therefore, it should be impossible to outperform the overall market through expert stock selection or market timing, and the only way an investor can obtain higher returns is by purchasing riskier investments. (source<\/a>)<\/p>\n\n\n\n

Inefficiencies are opportunities<\/h2>\n\n\n\n

Any market practitioner knows that this is not entirely true. There are numerous hurdles in the way of pure efficiency:<\/p>\n\n\n\n

  1. Information is not free. <\/p><\/li>

  2. Liquidity is not unlimited.<\/p><\/li>

  3. Prices are not continuous.<\/p><\/li>

  4. Market statistics are forever in flux.<\/p><\/li>

  5. Investors have different goals and pursue different outcomes.<\/p><\/li>

  6. Taxes, rules and regulations.<\/p><\/li><\/ol>\n\n\n\n

    According to EMH, a portfolio\u2019s return could be fully explained by the market (source<\/a>):<\/p>\n\n\n\n

    r<\/strong><\/em> = r<\/strong>f<\/code>+ <\/strong>\u00df<\/strong><\/em>(r<\/strong>m<\/code> – r<\/strong>f<\/code>) + \u03b1 <\/strong><\/h5>\n\n\n\n

    Where:<\/p>\n\n\n\n