Computational dynamics of information ratios

The information ratio is one of the most important measures when choosing among investment funds. We show numerically and analytically that the classic single-index definition of this performance measure suffers from a computational defect which unfavorably affects investment decisions by singling o...

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Bibliographic Details
Published inEconomics letters Vol. 236; p. 111611
Main Authors Auer, Benjamin R., Marohn, Marcel
Format Journal Article
LanguageEnglish
Published Elsevier B.V 01.03.2024
Subjects
Information ratio
Outlier sensitivity
Performance measurement
Regression
C02
Outlier sensitivity
C01
G11
Information ratio
Regression
Performance measurement
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Summary:The information ratio is one of the most important measures when choosing among investment funds. We show numerically and analytically that the classic single-index definition of this performance measure suffers from a computational defect which unfavorably affects investment decisions by singling out exceptionally good funds. Specifically, we highlight that high positive fund returns, which are in the best interest of the investors, can lead to suboptimal and even negative changes of the information ratio. Furthermore, we formally prove that fund managers have an incentive to target specific medium-sized returns because they generate the highest possible information ratio. •We show that the classic information ratio suffers from computational defects.•Exceptionally high fund returns can signal diminishing fund performance.•Fund managers have an incentive to avoid beneficial returns.
ISSN:0165-1765
1873-7374
DOI:10.1016/j.econlet.2024.111611