Simple and Optimal Alpha Strategy Selection and Risk Budgeting

Abstract:     
A simple measure is developed that can determine if investment efficiency is increased by including an alpha strategy. If the correlation between alpha and beta is lower than the ratio of information to Sharpe ratios, the strategy should be pursued. A combined alpha and beta Sharpe ratio measure is developed and used to determine a simple but optimal strategy for an alpha-beta risk budget. When alpha-beta correlation is zero, the risk budget is optimal at the ratio of the information to Sharpe ratios. An optimal risk budget for non-zero correlation is also addressed.

Number of Pages in PDF File: 15

Keywords: Risk budgeting, alpha, beta, active management, benchmarks

working papers series