Correlation Between BTM and HEDG
Can any of the company-specific risk be diversified away by investing in both BTM and HEDG at the same time? Although using a correlation coefficient on its own may not help to predict future stock returns, this module helps to understand the diversifiable risk of combining BTM and HEDG into the same portfolio, which is an essential part of the fundamental portfolio management process.
By analyzing existing cross correlation between BTM and HEDG, you can compare the effects of market volatilities on BTM and HEDG and check how they will diversify away market risk if combined in the same portfolio for a given time horizon. You can also utilize pair trading strategies of matching a long position in BTM with a short position of HEDG. Check out your portfolio center. Please also check ongoing floating volatility patterns of BTM and HEDG.
Diversification Opportunities for BTM and HEDG
Very weak diversification
The 3 months correlation between BTM and HEDG is 0.45. Overlapping area represents the amount of risk that can be diversified away by holding BTM and HEDG in the same portfolio, assuming nothing else is changed. The correlation between historical prices or returns on HEDG and BTM is a relative statistical measure of the degree to which these equity instruments tend to move together. The correlation coefficient measures the extent to which returns on BTM are associated (or correlated) with HEDG. Values of the correlation coefficient range from -1 to +1, where. The correlation of zero (0) is possible when the price movement of HEDG has no effect on the direction of BTM i.e., BTM and HEDG go up and down completely randomly.
Pair Corralation between BTM and HEDG
Assuming the 90 days trading horizon BTM is expected to generate 9.84 times less return on investment than HEDG. But when comparing it to its historical volatility, BTM is 3.84 times less risky than HEDG. It trades about 0.05 of its potential returns per unit of risk. HEDG is currently generating about 0.13 of returns per unit of risk over similar time horizon. If you would invest 2.27 in HEDG on January 20, 2024 and sell it today you would earn a total of 1.35 from holding HEDG or generate 59.47% return on investment over 90 days.
| Time Period | 3 Months [change] |
| Direction | Moves Together |
| Strength | Weak |
| Accuracy | 100.0% |
| Values | Daily Returns |
BTM vs. HEDG
Performance |
| Timeline |
| BTM |
| HEDG |
BTM and HEDG Volatility Contrast
Predicted Return Density |
| Returns |
Pair Trading with BTM and HEDG
The main advantage of trading using opposite BTM and HEDG positions is that it hedges away some unsystematic risk. Because of two separate transactions, even if BTM position performs unexpectedly, HEDG can make up some of the losses. Pair trading also minimizes risk from directional movements in the market. For example, if an entire industry or sector drops because of unexpected headlines, the short position in HEDG will offset losses from the drop in HEDG's long position.The idea behind BTM and HEDG pairs trading is to make the combined position market-neutral, meaning the overall market's direction will not affect its win or loss (or potential downside or upside). This can be achieved by designing a pairs trade with two highly correlated stocks or equities that operate in a similar space or sector, making it possible to obtain profits through simple and relatively low-risk investment.Check out your portfolio center.Note that this page's information should be used as a complementary analysis to find the right mix of equity instruments to add to your existing portfolios or create a brand new portfolio. You can also try the Watchlist Optimization module to optimize watchlists to build efficient portfolios or rebalance existing positions based on the mean-variance optimization algorithm.
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