Transactions on a Portfolio and Portfolio Strategies

Transactions on a Portfolio and Portfolio Strategies -...

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Transactions on a Portfolio  and Portfolio Strategies December 2, 2009 General Comments R 2  is a measure of % market (systematic) risk - Cannot be diversified away - Can, however, be hedged 1-R 2  is a measure of unsystematic risk - Can be diversified away (free) - Cannot, however, be hedged Diversification - Add new stocks to portfolio which have low correlations to existing stocks to reduce /  eliminate unsystematic risk in portfolio o Increases R 2  (eliminates unsystematic risk) - Example: β Return o Vanguard S&P 500 Index Fund +1.0 r M o Short S&P 500 Futures Contract -1.0 -r o Net Position 0 r f Stock Market Risk and Strategies Thereon Total Risk ( σ T 2  =  β 2 σ M 2  +  σ E 2 ) Systematic Risk (B ² * σ M ² ) Unsystematic Risk ( σ E ² ) Measure: β 1 – R ² Strategy: Hedge Systematic Risk ( =0) β Diversify Unsystematic Risk (R ² =1) Maintain Unsystematic Risk Maintain Systematic Risk (Return =  ) α (Return =  *R β M )
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