Leveraging Machine Learning in Quantitative Equity Strategies

Imagine you are the lead portfolio manager at Alpha Investments, a firm focused on quantitative strategies for active equity investing. You have been tasked with developing a new quantitative equity strategy that utilizes machine learning algorithms to identify mispriced stocks in the small-cap segment of the market. Your objective is to outperform the Russell 2000 Index over the next three years.

In your essay, discuss the rationale behind employing machine learning techniques in quantitative equity strategies. Highlight specific types of data that might be leveraged in your strategy, the expected advantages of using these techniques over traditional models, and the potential risks associated with machine learning approaches. Additionally, outline a framework for back-testing your strategy, specifying metrics you would use to evaluate performance and adjust your approach based on ongoing results.