Chapter 14: Latent Factor Models
Conditional Factor Structure: Why Characteristics Predict Loadings advanced
When firm characteristics predict factor loadings, the covariance matrix of returns is itself a function of observables -- and that conditional structure is what IPCA exploits and what static PCA ignores.
When firm characteristics predict factor loadings, the covariance matrix of returns is itself a function of observables -- and that conditional structure is what IPCA exploits and what static PCA ignores.
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References
Characteristics are covariances: A unified model of risk and return
Bryan T. Kelly, Seth Pruitt, Yinan Su
(2019)
— Journal of Financial Economics
Empirical Asset Pricing via Machine Learning
Shihao Gu, Bryan Kelly, Dacheng Xiu
(2020)
— The Review of Financial Studies