does optimization assume that factors are correlated.
i saw a question concerning a large index containing illequid securities assuming factors are uncorrelated.
Stratified sampling was chosen as the answer. i chose optimization.
large index, illiquid securities – what do you expect to achieve by optimization? When you see optimization think of solving a set of equations all simultaneously - linear programming models - to get at asset weights. But when you think about the underlying securities being illiquid - you would select a few of the many - so you have higher liquidity on your portfolio. So stratified sampling - would be the better answer.
Yes, optimization is the factor model accounts for the covariances between risk factors. In a stratified sampling procedure, it is implicitly assumed that the factors (e.g., industry, size, price-earnings ratios) are uncorrelated.
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