Combining Edges

It was early on when I started out in research that I found the academic space provides a lot of ideas and inspirational data. On such popped up this morning when I was over at CXO Advisory. They do such a great job in gathering and filtering out relevant research; I highly recommend them.

In the paper, The Supraview of Return Predictors, they combined a total of 333 stock return predictors varying from accounting based ratios all the way to priced based predictors like momentum. I though a picture would explain a thousand words…

Above graph’s Y-Axis is the gross Sharpe ratio while the X-Axis is the number of predictors. The different lines are varying correlations amounts predictors in portfolio. As the number of predictors included increases (equal-weighted), so would the Sharpe ratio.

The above image shows Sharpe Ratio (Y-Axis) versus the correlations (X-Axis) amongst predictor. The concept here has reinforced my own philosophy about combining uncorrelated strategies to achieve exceptional return.

Images source from paper.

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