Nov 05

Risk-adjusted performance measures (RAPMs) – 10 min briefcast

by David Harper, CFA, FRM, CIPM

FRM |

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This is an overview of the single-index risk-adjusted performance measures. Tips for FRM candidates:

  • These RAPMs are all variations of: return per unit of risk
  • Treynor and Sharpe are similar: both are excess return per unit of risk. Treynor defines risk as systematic risk (beta) and is therefore appropriate to well-diversified portfolios (i.e., into such portfolios idiosyncratic risk is eliminated); Sharpe defines risk as total risk (volatility).
  • Jensen’s alpha is outperformance relative to expected performance under CAPM. How is Jensen’s alpha different from Grinold’s alpha? Jensen’s alpha is a special case of Grinold’s alpha, which is more encompassing. Alpha = residual return = return over the benchmark. In Jensen’s, the benchmark is the market portfolio (or, if you like, the security market line is the benchmark).
  • The information ratio is alpha/tracking error; i.e., residual return/residual risk

Screencast:

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