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The Bankers Dozen is a hedged portfolio that measures the relative
preference for idiosyncratic risk, and when compared to treasury yields,
it can be used to gauge a risk equilibrium. The portfolio first assumes
that covariances do not reduce overall volatility, then adjusts the
security weights so the risk premium is equal to a portfolio that
includes these benefits. While offering the same risk premium as a
traditional portfolio, more idiosyncratic risk is present, so the
relative performance measures the relative preference for idiosyncratic
risk. Generally, if investors prefer certainty, the Bankers Dozen should
underperform the diversified market. Investors will also purchase
risk-free treasuries, driving bond yields lower. The benefits of
diversification increase with portfolio size, so the Bankers Dozen has
larger underperformance, creating a downward sloping preference, or
demand curve for idiosyncratic risk. This can be compared to the upward
sloping yield curve, or supply curve, to create a risk equilibrium. As
risk aversion increases, yields fall, and so does idiosyncratic
preference. Looking at monthly positions from 1994 to 2016, larger
portfolio sizes underperformed, and the overall downward trend with
yields was similar, with temporary breaks in the equilibrium. Looking at
daily positions from 2018 to 2023, there was outperformance and upward
movement in yields. Larger portfolio sizes did better, with both the
demand and supply curves flattening.
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