To diversify across risk factors may lead to better portfolio diversification and lower downside…

To diversify across risk factors may lead to better portfolio diversification and lower downside risk than would allocating across asset classes. While allocation across principal components would be a theoretically superior approach to risk factor diversification, practitioners typically prefer to use fundamental risk factors. Explain at least two challenges of principal component analysis and enumerate four of the key risk factors commonly used by practitioners.

 

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