Kent Smetters Presentation

A Sharper Ratio: A General Measure for Ranking
Investment Risks

Kent Smetters1 Xingtan Zhang2

1The Wharton School and NBER

2The Wharton School

March 2015

Disclaimer

No conflicts to report.

Size of active and passive indexing

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Rebalancing occurs at a higher frequency than risk measurement

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Mismatch of trading – risk intervals under-explored

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Example Baseline: 50 / 50 portfolio [1]

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Example Baseline: 50 / 50 portfolio [2]

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Example Baseline: 50 / 50 portfolio [3]

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Andy Lo’s “Capital Decimation Partners”

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But, you don’t invest in those strategies, right?

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Simple trading rule [1]

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Simple trading rule [2]

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Simple trading rule [3]

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Simple trading rule [4]

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Simple trading rule [5]

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Simple trading rule [6]

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Myth 1: “Max drawdown” is informative

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Myth 2: Multidimension Risk Management [1]

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Myth 2: Multidimension Risk Management [2]

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Myth 2: Multidimension Risk Management [3]

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Myth 3: Higher moments are hard to estimate [1]

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Myth 3: Higher moments are hard to estimate [2]

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Toward a Summary Statistic

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Sharpe Ratio [1]

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Sharpe Ratio [2]

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Sharpe Ratio [3]

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Sharpe Ratio [4]

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Sharpe Ratio [5]

But when Sharpe Ratio is not valid, it often “breaks, not bends”

Sharpe Ratio [5]

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Past Attempts to Extend SR [1]

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Past Attempts to Extend SR [2]

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Our approach: Solve the original truncated Taylor problem [1]

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Our approach: Solve the original truncated Taylor problem [2]

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New Measure [1]

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New Measure [2]

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New Measure [3]

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New Measure [4]

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“1. Independent of wealth” [1]

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“5. Ranking depends on r” [1]

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“5. Ranking depends on r” [2]

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“5. Ranking depends on r” [3]

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Summary and Intuition [1]

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Summary and Intuition [2]

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Concern 1: Does qH N (tY ;b) work with little data? [1]

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Concern 2: Is qH N (tY ;b) score too complicated? [1]

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Concern 2: Is qH N (tY ;b) score too complicated? [2]

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Concern 2: Is qH N (tY ;b) score too complicated? [3]

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Application 1: Ranking Smart Betas

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Market Cap Weighting

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Market Cap vs. Equal, Div, and Fund

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Adding Commercial Indices [1]

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Adding Commercial Indices [2]

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Intuition and Punchline

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Application 2: Active Manager Selection [1]

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Application 2: Active Manager Selection [2]

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Application 2: Manager Selection [3]

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Application 3: Multi-Asset Portfolio Optimization [1]

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Application 3: Multi-Asset Portfolio Optimization [2]

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Application 4: Is Piketty’s Endowment Example Right?

[GETTING DATA NOW]

Works Cited in Talk I

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