09. Risk Factors v. Alpha Factors part 2
M4 L1B 08 Risk Factors V Alpha Factors Part 2 V2
Characteristics of risk factors and alpha factors
Usually, we'd choose 20 to 60 risk factors that describe overall stock variance as much as possible. So risk factors as a whole account for more of the overall movement of stocks.
On the other hand, alpha factors contribute to smaller movements of stocks, which is okay, because we seek to identify these alpha factors because they give some indication of the direction of expected returns, even if they're small compared to risk factors.
An important reason why it's important to identify risk factors and then neutralize a portfolio's exposure to risk factors is that if we didn't, the asset movements due to risk factors would overwhelm the movements that are due to the alpha factors.