medium · Frm Part 2 Risk & Investment Management
A fund uses quadratic programming (QP) for portfolio construction. A risk audit finds that the model is 'error maximizing.'
What specific behavior of the QP optimizer is this referring to?
- The optimizer ignores transaction costs, leading to high turnover and 'decay' of alpha.
- The model fails to converge when the number of assets exceeds the number of data points.
- The optimizer loads aggressively on assets with overestimated alphas and underestimated correlations.
- The model uses historical simulation instead of a parametric covariance structure.
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