Gross exposure
Gross exposure is the absolute sum of long and short books. Selling stocks short generates cash, which can be used to enter additional long positions. In theory, leverage could be increased ad infinitum. In practice, prime brokers limit leverage to 3 or 4 times to limit their counterparty risk. Nobody wants to deal with margin calls at the first sign of a market hiccup.
Gross exposure has a direct impact on:
- Liquidity: The higher the leverage, the bigger the positions. This has a direct effect on market impact. This is especially felt on the short side, as the 2007 quants attest.
- Volatility: Leverage magnifies the volatility of returns.
- Performance: Leverage magnifies returns: A paltry 0.1% at low leverage can be juiced up to 0.5% and so on.
- Concentration: If the objective is to keep volatility low, the number of names should move in tandem with leverage: higher gross means more names and vice versa.
Gross exposure is ultimately...
