Is it possible to build a risk model that only has 2 industry risk factors? For example, if I wanted just Tobacco and Healthcare industries as risk factors can I do that? If I did that do I have to create a third bucket called other?
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$\begingroup$ You can make a model any way you want. Whether it produces the results you desire is a different story. $\endgroup$– amdoptJun 28, 2019 at 14:14
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1$\begingroup$ As this question currently is, it's not inviting (quality) answers. $\endgroup$– BramJun 28, 2019 at 14:16
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$\begingroup$ @Bram apologies I think it cut out half the question. The remainder was that if I do this do I have to bucket all of my other sectors into 1 factor? $\endgroup$– Rcwilkin1993Jun 28, 2019 at 14:25
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1$\begingroup$ You can build a model with only two risk factors. Build a General Equilibrium model that would deliveer Tobacco and Healthcare as the only two risk factors and no other factors is possible. Is it useful? No. You could match a few patterns in the data but you would be missing big elephants in the room. $\endgroup$– phdstudentJun 28, 2019 at 15:10
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If the information from a 3rd factor can be derived from the information in the other 2 factors, then the 3rd factor is redundant and is not necessary.
But as others have commented, probably not a great risk model. If one is uncomfortable with the risk in those sectors, it might be best to use a filter to screen those industries out of your portfolio.
