Risk models vs characteristic models from an investor’s perspective

Purpose: The purpose of this paper is to analyze the implications of the risk versus characteristic debate from the perspective of a mean-variance investor. Design/methodology/approach: Expected returns and the variance-covariance matrix are estimated based on various characteristic and risk models and evaluated for the purpose of mean-variance portfolios. Findings: Return estimates from characteristic models are most informative to investors. Risk-factor models provide the most informative estimates of the risk. A mean-variance investor should rely on combinations of the two model types. Originality/value: Although the risk vs characteristic debate is a binary academic debate, our findings from an investor's perspective suggest to make use of the best of both worlds.