Compare Two Equity Risk Models

Two candidate equity risk models provide factor exposures, factor covariance, and specific risk. Design an out-of-sample evaluation that determines which model is more useful for portfolio construction. Include predicted-versus-realized volatility, residual correlation, stability, coverage, and behavior across market regimes.

Constraints & Assumptions

• Model versions are reconstructed using only information available at each historical prediction date.
• Realized risk is noisy and must be measured over a future horizon.
• The production portfolios may differ from broad benchmark portfolios.
• A model can look accurate in aggregate while failing for important sectors, styles, or stress periods.

Clarifying Questions to Ask

• Which portfolios, holding horizons, and risk decisions will use the model?
• What minimum coverage and latency are required?
• Is the goal absolute risk, active risk, marginal risk, or all three?
• How costly are turnover, unstable exposures, and systematic residuals?