Comparing Strategy Risk Models on the Taiwanese Stock Market

Abstract

Since the first appearance of the fundamental law of active management, researchers have proposed several directions for its improvement. One important area is in active risk. As the authors explain, instead of using unconditional active risk as a risk estimator, a new source of active risk, strategy risk, has been added to risk models. This is of interest in models for strategy risk estimation and their application in specific conditions of emerging markets. The authors test three models proposed by Qian and Hua, Ye, and Ding and Martin and prove the theoretical consistency of Ding and Martin’s model, as it involves errors from cross-sectional forecasting. For the case of Taiwan, strategy risk presents an important share of all active risk. Here, the team proves that the main source of strategy risk remains the volatility of the information coefficient over time and note that errors from the cross-sectional forecasting model must be addressed in managers’ risk model.