Does Relaxing the Long-Only Constraint Increase the Downside Risk of Portfolio Alphas?

Abstract

We examine whether relaxing the long-only constraint increases the downside risk of portfolio alphas. We find that although stock returns are significantly positively skewed, particularly for small caps and stocks with negative earnings momentum, alphas of P/E and estimate revision strategies exhibit no significant skewness. Furthermore, in risk-controlled diversified portfolios, increasing short sales has little impact on the skewness of portfolio alphas. We view our results as evidence that relaxing the long-only constraint in traditionally long-only portfolios does not cause higher downside risk.