Correlation

Tactical Alpha in Theory and Practice (Part II): Principal Component Analysis

In Part I of this series, we explored Grinold’s Fundamental Law of Active Management, and why the theory leads to misguided conclusions in the presence of asset correlations. In this article we will offer a primer on a useful tool for portfolio evaluation, Principal Component Analysis (PCA), and illustrate how PCA can help quantify the number of independent bets in a portfolio of correlated assets.

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ReSolve Asset Management Blog is an investment research forum, opinion pieces, and educational material from the team at ReSolve Asset Management. Our views are driven by evidence based finance, with a special focus on asset allocation, factors and smart beta, retirement and endowment strategies, and quantitative methods.

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