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Quantitative Finance

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  • $\begingroup$ I thank you for your answer, I just can't help but be overthinking this ^^; . While the logic of what you just said makes perfect sense to me, I don't see how I could use it in practice, as in how I could get the co variances of each asset. $\endgroup$ Commented Jul 23, 2019 at 4:06
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    $\begingroup$ They're kind of different things. You could of course simply calculate them directly given the underlying asset returns. Alternatively, with factor returns, loadings for each for each security, and an assumption that the model is robust, you could calculate based on the factor returns and loadings as a stand-in. $\endgroup$ Commented Jul 23, 2019 at 4:58
  • $\begingroup$ Yes, to reduce dimensionality the model makes assumptions about the perturbations. These are made in a way to make the correlation matrix only dependent of the factors. Again, the original problem still has its dimensions, but the new problem has a lower dimensionality thanks to assumptions regarding the perturbations. $\endgroup$ Commented Jul 23, 2019 at 5:26