Book Image

Python for Finance Cookbook

By : Eryk Lewinson
Book Image

Python for Finance Cookbook

By: Eryk Lewinson

Overview of this book

Python is one of the most popular programming languages used in the financial industry, with a huge set of accompanying libraries. In this book, you'll cover different ways of downloading financial data and preparing it for modeling. You'll calculate popular indicators used in technical analysis, such as Bollinger Bands, MACD, RSI, and backtest automatic trading strategies. Next, you'll cover time series analysis and models, such as exponential smoothing, ARIMA, and GARCH (including multivariate specifications), before exploring the popular CAPM and the Fama-French three-factor model. You'll then discover how to optimize asset allocation and use Monte Carlo simulations for tasks such as calculating the price of American options and estimating the Value at Risk (VaR). In later chapters, you'll work through an entire data science project in the financial domain. You'll also learn how to solve the credit card fraud and default problems using advanced classifiers such as random forest, XGBoost, LightGBM, and stacked models. You'll then be able to tune the hyperparameters of the models and handle class imbalance. Finally, you'll focus on learning how to use deep learning (PyTorch) for approaching financial tasks. By the end of this book, you’ll have learned how to effectively analyze financial data using a recipe-based approach.
Table of Contents (12 chapters)

Implementing the Fama-French three-factor model in Python

In their famous paper, Fama and French expanded the CAPM model by adding two additional factors explaining the excess returns of an asset or portfolio. The factors they considered are:

  • The market factor (MKT): It measures the excess return of the market, analogical to the one in the CAPM.
  • The size factor, SMB (Small Minus Big): It measures the excess return of stocks with a small market cap over those with a large market cap.
  • The value factor, HML (High Minus Low): It measures the excess return of value stocks over growth stocks. Value stocks have a high book-to-market ratio, while the growth stocks are characterized by a low ratio.

The model can be represented as follows:

Or in its simpler form:

Here, E(ri) denotes the expected return on asset i, rf is the risk-free rate (such as a government bond), and α is...