Do tracking errors reliably estimate portfolio risk?

A Scowcroft and J Sefton
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A Scowcroft: UBS Warburg Ltd
J Sefton: UBS Warburg Ltd

Journal of Asset Management, 2001, vol. 2, issue 3, No 2, 205-222

Abstract: Abstract An active equity investment strategy aims to select a portfolio of stocks that are likely to outperform the market without exposing the investor to unacceptable levels of risks. The purpose of this paper is to assess whether tracking errors have historically accurately quantified these levels of risk in the UK. The results suggest that over the short-term horizons, tracking errors have performed reasonably well, but over the longer-term horizons (>1 year), they have tended to underestimate risk. We find evidence that this underestimation can be explained by a combination of transitory market momentum effects and changes to overall levels of market volatility. We also investigate how investment strategies of sector neutrality reduce levels of portfolio risk.

Keywords: tracking errors; portfolio risk; market volatility; transitory momentum (search for similar items in EconPapers)
Date: 2001
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DOI: 10.1057/palgrave.jam.2240046

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