Patent ID: 8533089

Claim:
A computer based method of constructing a factor index of portfolio weights comprising: selecting a set of possible investments; defining a benchmark portfolio comprising a set of holdings in the set of possible investments; selecting a first factor risk model defined for the set of possible investments, said first factor risk model comprising a matrix of factor exposures, a matrix of factor covariances, and a matrix of specific risk variances; selecting scores of a target factor which is a linear combination of factors defined by the first risk model; constructing utilizing a programmed computer a target factor portfolio for the target factor whose holdings are determined by the set of possible investments, the benchmark portfolio, the first factor risk model, and the target factor scores and whose exposure to the target factor scores is different than the exposure of the benchmark portfolio to the target factor scores; selecting a second factor risk model defined for the set of possible investments, said second factor risk model comprising a matrix of factor exposures, a matrix of factor covariances, and a matrix of specific risk variances, said second factor risk model being different than the first factor risk model; determining weights of each security for a factor index so that the tracking error between the factor index and the target factor portfolio as predicted by the second risk model is less than a prescribed amount; and outputting the factor index weights as an electronic output by the programmed computer.