Question #40
Reading: Reading 40 Analysis of Active Portfolio Management
PDF File: Reading 40 Analysis of Active Portfolio Management.pdf
Page: 17
Status: Correct
Correct Answer: A
Question
Pamela Grieve claims that her information coefficient is 0.20 on monthly bets on 10 stocks in the healthcare industry. Assuming unconstrained optimization, the reduction in her information ratio if her bets have a correlation coefficient of 0.45 as opposed to being truly independent is closest to:
Answer Choices:
A. 22%
B. 45%
C. 86%
Explanation
Grieve's breadth assuming independent bets = 10 × 12 = 120
Information ratio assuming independent bets =
= 0.20 ×
= 2.19
If the bets are correlated, BR =
New information ratio assuming correlated bets
= 0.20 ×
= 0.30
% reduction = 1 − 0.30/2.19 = 86.4%
(Module 40.4, LOS 40.f)
IC√BR
√120
=
= 2.20
N
1+(N−1)r
120
1+(120−1)0.45
IC√BR
√2.20