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Beta Hedging - Quantopian Lecture

Hedging

If we determine that our portfolio's returns are dependent on the
market via this relation

Yportfolio=α+βXSPY

then we can take out a short position in SPY to try to cancel out this
risk. The amount we take out is −βV where V is the total value of our
portfolio. This works because if our returns are approximated by
α+βXSPY, then adding a short in SPY will make our new returns be
α+βXSPY−βXSPY=α. Our returns are now purely alpha, which is
independent of SPY and will suffer no risk exposure to the market.

I get that the return we get from the new portfolio is independent of the return from SnP, say, but is there a way to eliminate Beta from the return as well?

1 response

I think that is why the short position is there, to eliminate beta from your portfolio.

The equation says your portfolio return equals alpha (your skill) + beta coefficient x market return. By taking beta co-efficient and multiplying it by your portfolio market V, and going short to this amount, you should have a hedge against the positive (long) beta of your portfolio, in effect 'eliminating' beta.