[email protected]
New Member
Hi David,
I am noticing some inconsistencies as it relates to Information Ratio, and specifically Jensen's Alpha & Tracking error. I'm wondering if using the active risk & active return (versus residual return & residual risk) in the Information Ratio depend on what the benchmark is defined to be.
In Jorion Chapter 1 - Question 13 Answers you indicate "ACTIVE" in each of the following (explanations):
d) active risk = tracking error
e) information ratio = alpha / tracking error = active return / active risk
BUT, In Amenc Chapter 4 Question 33.5 you indicate "RESIDUAL" in the choices and the Answer (explanation)
d) information ratio = residual return / residual risk
Amenc Chapter 4 Queston 32.1 Answer indicates that while it might be tempting to use the benchmark return, it is the active return, NOT the residual return (alpha)
*** So, does the BENCHMARK define whether it is residual vs active RETURN and similarly residual vs. active RISK that are used in the Information Ratio?
Also in Amenc question 32.1, I don't understand why we are told "the benchmark is the market (CAPM) and the benchmark return 'WAS' 8%". Why are there two benmarks referenced in the question? And, What does "was" mean? Has the benchmark changed, now making the alpha "residual" (not active)? Is it possible that "was" suggest that the prior period CAPM was 8% (& we need to recalculate the current CAPM). You say that alpha of 10%-8% is the "active" return, and not what we should use for the information ratio. I am just not fully understanding "active" versus "residual".
I am just wondering how we are to know whether to use active return and active risk (as indicated in Jorion) versus alpha & residual (as used in Amenc) in the information ratio.
Thanks.
Theresa
I am noticing some inconsistencies as it relates to Information Ratio, and specifically Jensen's Alpha & Tracking error. I'm wondering if using the active risk & active return (versus residual return & residual risk) in the Information Ratio depend on what the benchmark is defined to be.
In Jorion Chapter 1 - Question 13 Answers you indicate "ACTIVE" in each of the following (explanations):
d) active risk = tracking error
e) information ratio = alpha / tracking error = active return / active risk
BUT, In Amenc Chapter 4 Question 33.5 you indicate "RESIDUAL" in the choices and the Answer (explanation)
d) information ratio = residual return / residual risk
Amenc Chapter 4 Queston 32.1 Answer indicates that while it might be tempting to use the benchmark return, it is the active return, NOT the residual return (alpha)
*** So, does the BENCHMARK define whether it is residual vs active RETURN and similarly residual vs. active RISK that are used in the Information Ratio?
Also in Amenc question 32.1, I don't understand why we are told "the benchmark is the market (CAPM) and the benchmark return 'WAS' 8%". Why are there two benmarks referenced in the question? And, What does "was" mean? Has the benchmark changed, now making the alpha "residual" (not active)? Is it possible that "was" suggest that the prior period CAPM was 8% (& we need to recalculate the current CAPM). You say that alpha of 10%-8% is the "active" return, and not what we should use for the information ratio. I am just not fully understanding "active" versus "residual".
I am just wondering how we are to know whether to use active return and active risk (as indicated in Jorion) versus alpha & residual (as used in Amenc) in the information ratio.
Thanks.
Theresa
