beta expansion risk

why does hedging become less effective in down markets (due to beta expansion risk)?

When beta expands, then your position moves a lot quicker… therefore it becomes harder for you to forecast and correct for any movements (aka hedging). Maybe think of it in terms of a video game analogy: - Say you are playing a driving game: Your goal is to drive in a straight line, but your car gets pushed to the left or right randomly. - Think of beta as how quickly your car veers from the straight line. - The analogous situation to beta expansion risk is that you get pushed off the straight line much quicker. - The faster you get pushed off the straight line, of course, the more difficult it is for you to bring your car back correctly to the center line since it takes increased sensitivity/control… (“hedging” becomes less effective) Probably an imperfect explanation + analogy, but maybe helpful…

In times of stress correlations tend to go to an absolute value of 1. Problem is it’s tough to figure out ex ante whether it will be positive or negative.

in the CAIA readings, they have an example of beta expansion risk as follows: all HF managers start to short same security…then someone starts counter play=>short squeeze…maybe this is helpful