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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| Published in | Economics letters Vol. 236; p. 111611 |
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| Main Authors | , |
| Format | Journal Article |
| Language | English |
| Published |
Elsevier B.V
01.03.2024
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| Subjects | |
| Online Access | Get full text |
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| Abstract | 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. |
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| AbstractList | 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. |
| ArticleNumber | 111611 |
| Author | Marohn, Marcel Auer, Benjamin R. |
| Author_xml | – sequence: 1 givenname: Benjamin R. surname: Auer fullname: Auer, Benjamin R. email: benjamin.auer@uni-jena.de organization: Friedrich Schiller University Jena, Chair of Finance, Carl-Zeiß-Str. 3, 07743 Jena, Germany – sequence: 2 givenname: Marcel orcidid: 0009-0007-5718-6917 surname: Marohn fullname: Marohn, Marcel organization: Friedrich Schiller University Jena, Chair of Finance, Carl-Zeiß-Str. 3, 07743 Jena, Germany |
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| Cites_doi | 10.3905/jpm.2023.1.509 10.1111/j.1540-6261.2009.01500.x 10.1093/rfs/hhm025 10.3905/jpm.2023.1.517 10.1016/j.jbankfin.2009.01.005 10.1111/j.1468-036X.2006.00357.x 10.1287/mnsc.2020.3846 10.1111/jofi.12747 10.1017/S0022109018001345 10.1086/295508 10.1093/rfs/hhs085 10.1111/joes.12041 10.1017/S0022109014000350 10.3905/jpm.1992.409408 10.1093/rfs/hhm055 10.2469/faj.v71.n6.4 10.1016/S0378-4266(00)00160-6 10.1016/j.orl.2011.03.004 10.1111/jofi.12240 10.3905/JOI.2010.19.1.067 10.1080/23322039.2021.1902031 10.1016/j.jbankfin.2011.01.009 10.2469/faj.v54.n4.2196 10.1016/j.jbankfin.2006.09.015 10.3905/jai.2001.319019 10.1111/j.1468-036X.2008.00471.x 10.1007/s11408-013-0213-x 10.1016/j.econlet.2012.02.005 |
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| References | Schuster, Auer (b32) 2012; 116 Law, Kelton (b24) 1991 Goetzmann, Ingersoll, Spiegel, Welch (b18) 2007; 20 Campbell, Huisman, Koedijk (b11) 2001; 25 Bossert, Füss, Rindler, Schneider (b10) 2010; 19 Eling, Schuhmacher (b17) 2007; 31 Auer (b4) 2013; 27 Bollen, Pool (b8) 2009; 64 Bollen (b7) 2021 Zakamouline, Koekebakker (b35) 2009; 33 Akbas, Genc (b2) 2020; 55 Bodie, Kane, Marcus (b6) 2009 Kutner, Nachtsheim, Neter, Li (b23) 2004 Lim, Shanthikumar, Vahn (b26) 2011; 39 diBartolomeo (b15) 2023; 49 Paleologo (b27) 2023; 49 Goodwin (b19) 1998; 54 Patton, Ramadorai, Streatfield (b28) 2015; 70 Caporin, Jannin, Lisi, Maillet (b13) 2014; 28 Liang, Park (b25) 2007; 13 Grinold, Kahn (b21) 1992; 18 Jorion, Schwarz (b22) 2014; 49 Quarteroni, Sacco, Saleri (b30) 2007 Treynor, Black (b34) 1973; 46 Andersen (b3) 2007 Schuhmacher, Kohrs, Auer (b31) 2021; 67 Bollen, Pool (b9) 2012; 25 Polkovnichenko, Wei, Zhao (b29) 2019; 74 Derwall, Koedijk, Ter Horst (b14) 2011; 35 Greene (b20) 2008 Eling (b16) 2009; 15 Campbell, Thompson (b12) 2008; 21 Spurgin (b33) 2001; 4 Aboy, Magadia (b1) 2021; 9 Auer, Schuhmacher (b5) 2015; 71 Schuster (10.1016/j.econlet.2024.111611_b32) 2012; 116 Bodie (10.1016/j.econlet.2024.111611_b6) 2009 Jorion (10.1016/j.econlet.2024.111611_b22) 2014; 49 Auer (10.1016/j.econlet.2024.111611_b5) 2015; 71 Paleologo (10.1016/j.econlet.2024.111611_b27) 2023; 49 Akbas (10.1016/j.econlet.2024.111611_b2) 2020; 55 Lim (10.1016/j.econlet.2024.111611_b26) 2011; 39 Polkovnichenko (10.1016/j.econlet.2024.111611_b29) 2019; 74 Law (10.1016/j.econlet.2024.111611_b24) 1991 Schuhmacher (10.1016/j.econlet.2024.111611_b31) 2021; 67 Zakamouline (10.1016/j.econlet.2024.111611_b35) 2009; 33 Eling (10.1016/j.econlet.2024.111611_b16) 2009; 15 Goodwin (10.1016/j.econlet.2024.111611_b19) 1998; 54 Bollen (10.1016/j.econlet.2024.111611_b8) 2009; 64 Quarteroni (10.1016/j.econlet.2024.111611_b30) 2007 Goetzmann (10.1016/j.econlet.2024.111611_b18) 2007; 20 Auer (10.1016/j.econlet.2024.111611_b4) 2013; 27 Campbell (10.1016/j.econlet.2024.111611_b12) 2008; 21 Andersen (10.1016/j.econlet.2024.111611_b3) 2007 Bossert (10.1016/j.econlet.2024.111611_b10) 2010; 19 Campbell (10.1016/j.econlet.2024.111611_b11) 2001; 25 Bollen (10.1016/j.econlet.2024.111611_b9) 2012; 25 Derwall (10.1016/j.econlet.2024.111611_b14) 2011; 35 Eling (10.1016/j.econlet.2024.111611_b17) 2007; 31 Kutner (10.1016/j.econlet.2024.111611_b23) 2004 diBartolomeo (10.1016/j.econlet.2024.111611_b15) 2023; 49 Aboy (10.1016/j.econlet.2024.111611_b1) 2021; 9 Greene (10.1016/j.econlet.2024.111611_b20) 2008 Treynor (10.1016/j.econlet.2024.111611_b34) 1973; 46 Patton (10.1016/j.econlet.2024.111611_b28) 2015; 70 Spurgin (10.1016/j.econlet.2024.111611_b33) 2001; 4 Grinold (10.1016/j.econlet.2024.111611_b21) 1992; 18 Caporin (10.1016/j.econlet.2024.111611_b13) 2014; 28 Liang (10.1016/j.econlet.2024.111611_b25) 2007; 13 Bollen (10.1016/j.econlet.2024.111611_b7) 2021 |
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| Snippet | The information ratio is one of the most important measures when choosing among investment funds. We show numerically and analytically that the classic... |
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| SubjectTerms | Information ratio Outlier sensitivity Performance measurement Regression |
| Title | Computational dynamics of information ratios |
| URI | https://dx.doi.org/10.1016/j.econlet.2024.111611 |
| Volume | 236 |
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