Standard Deviation of Excess Return
Understanding Standard Deviation of Excess Return
When evaluating the performance of our investment portfolio, it’s crucial to understand the concept of the standard deviation of excess return.
This statistical measure tells us the amount by which the returns of our portfolio, above a baseline comparison such as a benchmark index, spread around the average or expected excess returns.
A lower standard deviation indicates that the excess returns of our portfolio are closely clustered around the mean, suggesting less volatility.
To put it simply, consider the excess return as the additional gain we receive from an investment compared to a risk-free rate or a benchmark. It’s the extra reward for taking on more risk.
However, not all excess returns are consistent; they typically fluctuate over time. We use standard deviation to quantify that variability.
Here’s a quick reference table:
Term | Definition |
---|---|
Excess Return | The return on an investment or portfolio over and above a benchmark or risk-free rate. |
Standard Deviation | A measure illustrating the dispersion or variability of a set of values. |
Information Ratio | A portfolio’s return relative to a benchmark, adjusted for volatility. |
Understanding the standard deviation of these excess returns can help us make more informed decisions in the context of investing.
By monitoring this measure, we’re better equipped to assess a portfolio’s risk-adjusted performance and compare it to others.
If we notice that our portfolio’s excess returns have a high standard deviation, that could indicate a higher level of risk or potential for wide fluctuations in performance.
An instrument that helps us grasp the efficiency of these returns is the Information Ratio, which takes standard deviation into account.
It gauges how much additional return we’re receiving per unit of risk. High values suggest we’re on the right track, effectively managing the balance between risk and return.
Understanding this concept is vital for us as investors. It helps us to anticipate the risk involved with our investment choices and align them with our risk tolerance and portfolio objectives.