A model that explains asset returns by their exposures to a small number of common risk factors. It splits return into factor-driven and specific parts.
Where you will meet it
Factor model comes up in 9 learning outcome notes across the FRM syllabus.
A few of them:
The Arbitrage Pricing Theory and Multifactor Models of Risk and Return FRM Part I · Foundations of risk management
“A multifactor model writes an asset's return as a constant, plus a beta times a factor for each factor, plus a residual.”
Measuring Credit Risk FRM Part I · Valuation and risk models
“Correlation between borrowers comes from a factor model for their asset or equity returns, applied through a Gaussian copula.”
Portfolio Credit Risk FRM Part II · Credit risk measurement and management
“In the single factor model each firm's standardised asset return is Ri = βi × M + √(1 − βi²) × ei.”
Factor Theory FRM Part II · Risk management and investment management
“A multifactor model builds expected return from several priced factors.”
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