{ "cells": [ { "cell_type": "markdown", "metadata": {}, "source": [ "# Why You Should Hedge Beta and Sector Exposures (Part II)\n", "by Jonathan Larkin and Maxwell Margenot\n", "\n", "Part of the Quantopian Lecture Series:\n", "\n", "* [www.quantopian.com/lectures](https://www.quantopian.com/lectures)\n", "* [github.com/quantopian/research_public](https://github.com/quantopian/research_public)\n", "\n", "\n", "---\n" ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "In the first lecture on [Why You Should Hedge Beta and Sector Exposure](quantopian.com/lectures/why-you-should-hedge-beta-and-sector-exposures-part-i), we covered the information coefficient (IC) and effective breadth, providing yet more reasons to make as many independent bets as possible. Here we expand upon the concepts detailed there by decomposing portfolios of varying numbers of securities to further explore the effects of systematic risk." ] }, { "cell_type": "code", "execution_count": 1, "metadata": { "collapsed": true }, "outputs": [], "source": [ "import numpy as np\n", "import matplotlib.pyplot as plt" ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "## Hedging Beta and Sector Risk is Good for Allocators (Which is Good for You!)\n", "\n", "Let's work from two basic beliefs:\n", "- You would like someone to fund your algorithm\n", "- The institution that funds your algorithm is not going to allocate 100% of its money to you. In other words, your algorithm is one in a portfolio of algorithms.\n", "\n", "The implication of the second belief is subtle. Why should it matter that your high Sharpe algo is part of a portfolio? The key to understanding the importance of this and what it has to do with beta and sector exposure is the following mathematical result:\n", "\n", "**In a portfolio, stock specific risk can be diversified out while common factor risk cannot.**" ] }, { "cell_type": "markdown", "metadata": {}, "source": [ "