Independent Factor Model in Portfolio Management
(L. W. Chan)

Factor Model is a fundamental model in finance and many financial theories are established based on it; for examples, Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT). The factor model describes the security returns as linear combinations of a set of factors. Traditional factor model assumes the factors are uncorrelated to each other. However, in order to construct a portfolio which hedges out some undesirable effects, we prefer to construct factor models using independent factors, not just uncorrelated factors. In this project, we apply the Independent Component Analysis (ICA) to construct factor models, and we name the models as Independent Factor Models (IFM). Evaluation of the Independent Factor Models using statistical tests and the advantages of IFM in portfolio analysis will be studied.