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One of three types of models that try to explain risk/reward relationships based on two or more factors. Macroeconomic factor models use observable economic time series as measures of the factors correlated with security returns. Fundamental factor models use many of the measurements generated by securities analysts such as price/earnings ratios, industry membership, company size, book-to-price, financial leverage, dividend yield, etc. Statistical factor models generate statistical constructs which have no necessary fundamental or macroeconomic analogs, but which explain, in the statistical sense, many of the relationships of security returns from the security return data alone. Factor models are used to predict portfolio behavior and, in conjunction with other tools, to construct customized portfolios that have certain desired characteristics, such as the ability to track the performance of indexes or other portfolios. Also called Factor Model. See Arbitrage Pricing Theory (APT), Factor, Eigenvectors, Factor Analysis.
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