Computational dynamics of information ratios

Benjamin R. Auer and Marcel Marohn

Economics Letters, 2024, vol. 236, issue C

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.

Keywords: Information ratio; Performance measurement; Regression; Outlier sensitivity (search for similar items in EconPapers)
JEL-codes: C01 C02 G11 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:236:y:2024:i:c:s0165176524000946

DOI: 10.1016/j.econlet.2024.111611

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