# Factor Reduction / Principal Component Analysis

## Java Applet

Alternatively you may launch this applet using Java WebStart.
Minimum requirements: Java 1.6. Tested with Firefox and Safari. Source code for the underlying library is available at
finmath.net.

**IMPORTANT:** The applet is currently *self-signed*. Hence it will no longer run under the Java security level "high", which has become default. **In order to run the applet, you need to add the domain **`http://christian-fries.de` to the *Exception Site List*. To edit the *Exception Site List* open the Java control panel, select the `Security` tab, then press `Edit Site List`.

## Description

This tool illustrates the impact of a factor reduction on a correlation matrix.

It serves as a companion to Appendix B.3 of Mathematical Finance.

### Predefined Scenarios

Your may step through five predefined scenarios.

Scenario 1 |
Scenario 2 |
Scenario 3 |
Scenario 4 |
Scenario 5 |

Reduction to one factor (trivial). |
Reduction to two factors. |
Reduction to five factors. |
Reduction to two factors starting from a setting of high correlation. |
Reduction to five factors starting from a setting of high correlation. |

The scenarios 1-3 give a first impression of what a factor reduction does. Increasing the number of factors we will catch more and more of the original correlation structure. The scenarios 4 and 5 show that for some situations it is sufficient to use one 2 or 3 factors to capture the correlation structure.

© Copyright 2007,2013 Christian P. Fries