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.


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