Active risk is affected by:
- cross-correlation : lower correlation between stocks or sectors = more active risk
Why exactly is it like that? Is the correlation considered between the stocks in your portfolio, or between the stocks in your portfolio and the ones in the benchmark?
If the correlation is LOW, they move in opposite directions… why does this lead to high active risk? Because you need to deviate more, to achieve risk reduction? 2. idiosyncratic risk : low idiosyncratic risk (from DIVERSIFICATION) = low active risk
Is this because your benchmark is also diversified? So, your return aren´t very dispersed compared to the benchmark… 3. net exposure to a risk factor : high net exposure leads to high level of active risk
Number 3 is clear. a portfolio with no net factor exposure (single factor, with factor exposure being neutralized) will have active risk attributed entirely to Active Share. What does this exactly mean? Factor exposure being neutralized meaning your long & short positions to only one factor exactly match? So why is active risk attributable entirely to active share?
Thank you so much!