# Tracking error formula in 1.b.5

Discussion in 'P1.T1. Foundations of Risk (20%)' started by Gary2584, Aug 10, 2012.

1. ### Gary2584New Member

Hi David,

In the practice bag spreadsheet for the tracking error calculation, i am confused on the logic behind the formula used for calculation. TE = Voltality(R(portfolio) - R(benchmark portfolio)) but am not able to correlate the above mentioned formula to the one used in the spreadsheet.

Thanks,
Gary
2. ### David Harper, CFA, FRM, CIPMDavid Harper

Hi Gary,

can i ask you to leave open (not post in) David's Notebook? I am moving this to Foundations

this is the only way to get an ex ante Tracking error: as the variance(A - B) = variance(A) + variance (B) - 2*covariance, the standardDeviation(P - M) = SQRT[Variance(P - M)] = sqrt[volatility(P)^2 + volatility(M)^2 - 2*vol(P)*vol(M)*correlation(P,M)]; i.e., elegant application of variance property

Now that you ask me about this, I noticed that I need to revise this XLS to make a note that this TE is an ex ante tracking error based on active return/active risk rather than residual return/residual risk.

Thanks, David
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3. ### Gary2584New Member

Hi David,
Thanks for letting me know, as i was kinda confused where to put my query relating to the Focus review.

Gary
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