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Performance Evaluation and Risk Management: Mcgraw-Hill/Irwin
Performance Evaluation and Risk Management: Mcgraw-Hill/Irwin
13 Performance Evaluation
and Risk Management
McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
It is Not the Return On My Investment ...
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However,
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Performance Evaluation
and Risk Management
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Performance Evaluation
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Performance Evaluation Measures
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Performance Evaluation Measures
The Sharpe Ratio
Rp R f
Sharpe ratio
σp
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Performance Evaluation Measures
The Treynor Ratio
Rp R f
Treynor ratio
βp
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Performance Evaluation Measures
Jensen’s Alpha
α p R p R f β p E R M R f
“Extra” Actual CAPM Risk-Adjusted ‘Predicted’ Return
Return return
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Jensen’s Alpha
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Investment Performance Data and
Portfolio Performance Measurement
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Investment Performance Measurement on the Web
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Comparing Performance Measures, I.
Sharpe ratio:
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Comparing Performance Measures, II.
Treynor ratio and Jensen’s alpha:
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Sharpe-Optimal Portfolios, I.
Expected ×
Return ×
×
×
× ×
× ×
×
× × ×
× ×
×
×
Standard deviation
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Sharpe-Optimal Portfolios, II.
• The slope of a straight line drawn from the risk-free rate to where the
portfolio plots gives the Sharpe ratio for that portfolio.
Expected A
Return × E R A R f
slope
σA
Rf
Standard deviation
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Sharpe-Optimal Portfolios, III.
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Example: Solving for a
Sharpe-Optimal Portfolio
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Portfolio Variance : σ P2 x S2 σ S2 x B σ B2 2x S x B σ S σ B CORR(R S ,R B )
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Example: Using Excel to Solve for
the Sharpe-Optimal Portfolio
Data
Inputs:
ER(S): 0.12 X_S: 0.250
STD(S): 0.15
ER(B): 0.06 ER(P): 0.075
STD(B): 0.10 STD(P): 0.087
CORR(S,B): 0.10
R_f: 0.04 Sharpe
Ratio: 0.402
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Example: Using Excel to Solve for
the Sharpe-Optimal Portfolio, Cont.
• Now, we let Excel solve for the weight in portfolio S that maximizes
the Sharpe Ratio.
Data Changer
Inputs: Cell:
ER(S): 0.12 X_S: 0.700
STD(S): 0.15
ER(B): 0.06 ER(P): 0.102
STD(B): 0.10 STD(P): 0.112
CORR(A,B): 0.10
R_f: 0.04 Sharpe
Ratio: 0.553 Target Cell Well, the guess
of 0.25 was a
tad low….
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Investment Risk Management
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Value-at-Risk (VaR)
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Example: VaR Calculation
• That is, one year from now, what is the probability that
your portfolio value is down by 7 percent (or more)?
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Example: VaR Calculation, II.
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Example: VaR Calculation, III.
• When the return is outside this range, half the time it will
be above the range, and half the time below the range.
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Example: A Multiple Year VaR, I.
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Example: A Multiple Year VaR, II.
13 + 13 = 26%
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Example: A Multiple Year VaR, III.
or
Prob (–30 RS&P500 82) .95
• The return will be outside this range 5 percent of the time. When the
return is outside this range, half the time it will be above the range,
and half the time below the range.
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Computing Other VaRs.
Prob R p,T ER p T 2.326 σ p T 1%
ProbR p,T
ER p T 1.96 σ p T 2.5%
ProbR p,T
ER p T 1.645 σ p T 5%
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Useful Websites
• Performance Evaluation
– Performance Evaluation Measures
• The Sharpe Ratio
• The Treynor Ratio
• Jensen’s Alpha
• Comparing Performance Measures
– Sharpe-Optimal Portfolios
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