McGraw-Hill

238 Managing Portfolios
bound to ignore pertinent pricing information. A better approach
would be to consider all the stocks in the universe, in order to glean
the greatest amount of information possible. At the same time, one
doesn’t wanto ignore the fact that the equity universe is characterized
by subsets of stocks that behave similarly to one another and
differently from the stocks in other subsets.
A complex equity market, one that is neither completely integrated
nor discretely segmented, calls for a valuation approach t
considers the largest possible universe of stocks, while taking into
account the differences between subsets that are captured by specific
style models. In addition to a coherent evaluation framework,
such an approach offers two major advantages over specific subset
models.
First, it is likely to provide more robust results. Because a
model based on extensive and heterogeneous data better controls
for multicollinearity in the independent variables, its parameter estimates
are more efficient. Second, because of its range and depth of
coverage, it is poised to take advantage of more profit opportunities
than a more narrowly defined subset model proffers.
A UNIFIED MODEL
The unified approach starts with a blank slate, having no bi-
ases regarding any particular group or groups of stocks. It searches
built-
.the widest possible universe for insights that may offer profitable
investment opportunities. Rather than focusing on one a or few attribute-a
DDM derivation of value, say, or stock P/E level, or
firm size-the unified model is multidimensional. It includes the
largest number of pertinent variables possible. In addition to a company’s
industry affiliations, the model may look, for example, at
price/eamings and price/casMow, size and neglect, beta and idiosyncratic
risk, return reversal and momentum.
Sigle-factor models of these variables offer only naYve indication
of their relationships to price behavior. Such models cannot
tell us how much of any detected correlation between P/E and price
changes, for example, actually reflects variables such as firm size
and/or industry affiliation, which are not included
the model. Simultaneous
modeling of all these variables across companies can