Factor Research Framework

Purpose

Systematically evaluates the predictive power of single or multiple factors. Uses IC/IR statistical tests and quantile backtests to determine whether a factor has stock-selection power, and to guide factor screening and combination.

Applicable scenarios:

• Single-factor validity testing (momentum, value, quality, volatility, and more)
• Determining weights for multi-factor combination
• Factor decay analysis (IC changes across different holding periods)
• Comparing factor differences across industries and markets

Workflow

1. Calculate factor values: compute factor exposures for each instrument on the cross-section, and output a factor CSV (index=date, columns=codes)
2. Calculate returns: compute each instrument's forward N-day return, and output a return CSV (same structure)
3. Call the factor_analysis tool: pass in the factor CSV, return CSV, and output directory
4. Interpret the results: judge factor validity based on IC/IR criteria and quantile backtest results
5. Factor screening / combination: keep effective factors and combine them with equal weights or IC-based weights

Key point: the rows (dates) and columns (instrument codes) of the factor CSV and return CSV must align exactly. Returns must be forward returns after the factor-observation date (to avoid look-ahead bias).

factor_analysis Tool Parameters

Parameter	Type	Required	Default	Description
factor_csv	string	Yes	-	Path to the factor-value CSV
return_csv	string	Yes	-	Path to the return CSV
output_dir	string	Yes	-	Output directory for results
n_groups	integer	No	5	Number of quantile groups

Output Files

File	Contents
ic_series.csv	Daily IC series
ic_summary.json	IC mean, IC standard deviation, IR, proportion of IC > 0
group_equity.csv	Cumulative equity curves for each quantile group

IC/IR Interpretation Standards

Metric	Threshold	Interpretation
IC mean	> 0.03	Factor has basic predictive power
IC mean	> 0.05	Factor has strong predictive power
IC mean	> 0.10	Unusually high; check for look-ahead bias
IR (IC mean / IC std)	> 0.5	Factor is stably effective
IR	> 1.0	Extremely strong, very rare
Proportion of IC > 0	> 55%	Factor direction is stable
Proportion of IC > 0	< 50%	Factor direction is unstable and unusable

Note: negative IC can also be useful (reverse factors). Judge by absolute value, and reverse the signal direction in actual use.

Quantile Backtest Interpretation

Quantile backtesting sorts instruments into N groups by factor value from low to high (default 5 groups), with equal-weight holding inside each group.

Criteria:

• Monotonicity: the final net values from Group_1 to Group_N should show a monotonic rising (or falling) pattern. Better monotonicity means stronger factor discrimination
• Long-short spread: the net-value difference between the highest and lowest group (long_short_spread). A larger spread means stronger selection power
• Nonlinearity: if only the top and bottom groups differ materially while the middle groups are similar, the factor may only be effective in the tails
• Stability: group equity curves should be smooth; sharp swings indicate an unstable factor

Warning signs:

• No meaningful difference across group equity curves → the factor is ineffective
• Non-monotonic pattern (such as V-shape or inverted V-shape) → the factor may have a nonlinear relationship and requires further analysis
• One group's net value falls persistently → the factor may be usable in reverse

Factor Combination Methods

When multiple single factors pass validity tests, they should be combined into a composite factor:

Equal-Weight Combination

The simplest method: standardize each factor and sum them with equal weights. Suitable when the factor count is small and IC differences are minor.

Composite factor = Z(factor1) + Z(factor2) + ... + Z(factorN)
where Z() is cross-sectional Z-score standardization

IC-Weighted Combination

Assign weights according to historical IC mean. Factors with higher IC receive larger weights.

weight_i = |IC_mean_i| / sum(|IC_mean_j|)
Composite factor = sum(weight_i * Z(factor_i))

Orthogonalized Combination

First orthogonalize the factors with the Schmidt process to remove collinearity, then combine them with equal weights. Suitable when factors are highly correlated with one another.

1. Sort factors by IC from high to low
2. Keep the first factor unchanged
3. Regress each later factor on all previous factors and use the residual as the orthogonalized factor
4. Combine the orthogonalized factors with equal weights

Reusable Cross-Sectional Transforms

Use quantlib_call with module="neutralization" (or import src.quantlib.neutralization) for tested transforms rather than retyping a regression. neutralize_factor removes named numeric/classification exposures with OLS or WLS. pca_factors compresses correlated factor columns into uncorrelated components; PCA alone does not make a factor industry/style neutral.

Panels use observation-time rows and asset columns. Minute, hourly, daily, weekly, monthly and irregular observations all use the same contract: each row is fitted independently, with no resampling, forward filling or full-period fit. Single-asset time-series residualization is a different model and is not provided. Align controls, weights, classifications and the tradable mask to information available at that observation time; the library cannot verify publication dates.

control_selection="explicit" is the default. Optional "auto" filters the supplied controls in insertion order by current coverage, rank and remaining degrees of freedom. It reports every selection/drop and never uses IC, returns or test-period performance. Supply economically justified controls: automatic quality filtering cannot decide which economic exposures should be removed. Missing/nonpositive WLS weights are excluded, not replaced. Missing exposures remain missing; rank-deficient explicit fits and empty auto selections skip the observation with diagnostics rather than silently changing the requested model.

Inspect coverage and Pearson exposure before/after on the same sample. WLS reports weighted exposure; unweighted or rank correlations need not be zero. Residual standardization is linear (no post-fit clipping/ranking), preserving the fitted orthogonality. Exact zero residuals are reported as such, not as an effective new factor. Compare raw/residual IC and group backtests separately with factor_analysis, using identical universes, masks and holding horizons. The transform itself does not calculate Sharpe, trading costs or turnover.

PCA reports per-time loadings, centering/scales, retained variance and component counts. Its loading-sign convention does not guarantee stable component identity across time; near-equal eigenvalues can rotate. Choose component counts/variance thresholds using research/training data rather than test-period performance.

See the neutralization workflow for Python and JSON-envelope examples, diagnostics and limits.

Common Pitfalls

Look-Ahead Bias

• Factor values must be computed using data from day T and earlier, while returns must use data from T+1 to T+N
• Wrong example: calculate the factor with day T closing price and correlate it with day T return → artificially inflated IC
• Correct approach: factor value at day T, return defined as the move from the T close to the T+1 close and beyond

Skewed Factor Distributions

• Some factors (such as market cap and turnover) have heavily right-skewed distributions
• Computing IC directly from raw values makes the result dominated by outliers
• Solution: apply cross-sectional rank or Z-score standardization before computing IC

Industry Neutralization

• Factor values can be highly similar within the same industry, causing stock selection to cluster in a few sectors
• Solution: perform Z-score standardization within each industry (industry neutralization) to remove industry effects
• For China A-shares, Shenwan Level-1 industries can be used

Insufficient Sample Size

• Each cross-section should contain at least 5 valid instruments to compute meaningful IC
• Quantile backtests require at least n_groups instruments
• When the universe is too small, IC is noisy and IR becomes unreliable

Factor Crowding

• Classic factors (momentum, value) may see diminished excess returns after becoming widely used
• Regularly inspect the time-series evolution of factor IC to see whether decay is occurring
• Consider factor innovation or factor timing

Survivorship Bias

• Backtesting only on stocks that still survive today will overestimate factor performance
• Use full-sample data including delisted stocks

Dependencies

pip install pandas numpy scipy

Calling Zoo Factors

Rather than recompute factors from raw OHLCV every research iteration, prefer reusing the 450+ pre-built alphas in the Alpha Zoo registry. Each alpha is metadata-validated (AlphaMeta schema with theme, universe, columns_required, decay_horizon, min_warmup_bars), shape-checked against panel["close"], and rejected if it emits +/- inf or >95% NaN — so the factor CSV you feed to factor_analysis is already sanity-checked.

from src.factors.registry import Registry

registry = Registry()
ids = registry.list(theme="momentum", universe="equity_cn")  # filter the catalogue
factor_panel = registry.compute("alpha101_001", panel)        # wide DataFrame, same shape as panel["close"]
factor_panel.to_csv("factor_alpha101_001.csv")                # ready for factor_analysis tool

For combining several validated alphas into one composite signal, see the multi-factor skill's ZooSignalEngine (it z-scores, weights, and ranks alphas for you, with per-alpha skip isolation). For browsing the catalogue and inspecting individual __alpha_meta__ records, see the alpha-zoo skill.

Artifact Placement

When factor_analysis runs inside a backtest or swarm run, set output_dir to <run_dir>/artifacts/factor/<factor_name>/ so the Run Detail Factor tab can render the results. Use one subdirectory per factor (for example artifacts/factor/momentum_20d/), and keep the three standard output files (ic_series.csv, ic_summary.json, group_equity.csv) together inside it. Artifacts written elsewhere under artifacts/ are still discovered by the recursive scan, but the canonical layout keeps runs comparable.