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I would like to generalize Paul Teetor's A Better Hedge Ratio, which uses prcomp() to determine a ratio between two legs. I am hoping to extend this to multiple legs, but am having trouble finding accurate results. Any suggestions?

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1 Answer 1

In the case of N components:

  1. compute the NxN covariance matrix
  2. compute the N eiggenvectors and take the one that has the signs that you want
  3. the weights of this eiggen vector corresponds to the basket of N components that you wish to create
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