What Is Beta-hedged?

A position or factor is beta-hedged when its exposure to the broad market (its market beta) has been neutralised, typically by shorting an index or futures in proportion to the position’s beta. What remains is the idiosyncratic or factor-specific return, stripped of the general up-and-down of the market.

Beta-hedging matters in factor investing research because comparing raw factor returns can be misleading if some factors carry hidden market exposure. Hedging out beta isolates the pure factor premium, making Sharpe ratios comparable across factors. It is the factor-research analogue of delta hedging in options.

Example: the ten Fama-French and AQR factors in Green Lark’s study were each beta-hedged before the mean-variance optimisation, so the optimiser allocated across clean factor premia rather than across disguised market exposure.

See also

• Market neutral strategy

• Delta hedged

• Capital asset pricing model

• Factor investing