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Incorporating Risk in Factor Investing
In factor investing, to ensure future success, one must consider the presence of additional risk or systematic behavior errors in the market. Factors like value and momentum may exhibit lower prices due to overreactions to news or inherent risk. For effective factor investing, understanding why a factor exists involves identifying underlying risks or ongoing systematic behavior errors. Momentum, for example, is often attributed to investor anchoring and herding behavior rather than a risk-based argument, highlighting the importance of incorporating risk in analyzing market anomalies.