Kpi – Key Performance
- 1. KPI – (KEY INVESTMENT PERFORMANCE) MEASUREMENT INDICATORS I SYED ADEEL HUSSAIN QUANTITATIVE RISK ANALYTICS DESKVenue: TIIB – HEAD OFFICETuesday, April 13, 20101
- 2. Key Asset Risk – Return Attribution Drivers :
- 3. Market Risks : Interest rates, equity prices, commodity prices , exchange rates, property prices, credit spreads, index returns..etc.
- 4. Credit Risks: ECAI Ratings, expected changes in Collateral Coverage, Probability of Default, Recovery rates, Loss Given Defaults. ....etc.Tuesday, April 13, 20102
- 5. Operational Risks: Pricing anomalies , Model Arbitrage , Imperfect Hedging, Transactional Risks, Uncovered Interest Parity .......etc.
- 6. Liquidity Risks: Buy – Side illiquidity , Sell –side Illiquidity , Roll Over Risks, Market Inability Risks...etc.Tuesday, April 13, 20103
- 7. (RISK ADJUSTED RETURN PEFORMANCE MEASURES ) – RAPM’S
- 8. To measure risk adjusted return performances as a function of drivers/ attribution factors we need to identify quantitative appraisal metrics for all investment asset classes. Tuesday, April 13, 20104
- 9. Some of the 1st , 2nd and 3rd Generation Key Performance Measurement Models applied are :
- 10. Sharpe Ratio
- 16. SHARPE RATIO – by Professor William Sharpe (1966)
- 17. The metric is the defined as the total risk to reward ratio
- 18. It can also be described as slope of the SML – (Security Market Line) derived from the CAP-M theory
- 19. Compute Average Returns of last twelve months
- 20. Compute Average Volatility of returns of last twelve months
- 21. Select Risk -Free Rate (Ideally 3 Month US T-Bill
- 22. Compute Annualized Excess Returns) .Tuesday, April 13, 20106
- 23. Divided Annualized Excess Returns by Annualized Volatility (Annualized standard deviations of 12 month return samples)
- 24. Numerically the Sharpe Risk to Reward Ratio can be expressed as:
- 25. Annualized Excess Returns/ Annualized Volatility of Returns Tuesday, April 13, 20107
- 26. Drawbacks of Sharpe Ratio
- 27. Unit Less Ratio of performance measurement
- 28. Doesn't distinguish between good and bad volatility
- 29. Penalizes investors for upside price deviations.
- 30. Not suitable for evaluating/ ranking performance of complex financial products Tuesday, April 13, 20108
- 31. All else equal, the portfolio’ Sharpe ratio should decrease if we increase the risk (volatility). By looking at its formula, you can see that this is true only when the Sharpe ratio is positive.
- 32. However, with a negative Sharpe ratio, increasing risk results in a larger Sharpe ratio. Therefore, Sharpe ratio should not be used as a measure to compare portfolios that have a negative Sharpe ratio value.
- 33. The Ratio formula assumes that the risk free rate is constant, but we all know this is false. Tuesday, April 13, 20109
- 34. The Sharpe Ratio uses only the standard deviation as a measure of risk. This can be problematic when calculating the Ratio for asymmetric returns because the Standard deviation is most appropriate as a measure of risk for strategies with approximately symmetric return distributions.
- 35. The Ratio is based on historical data, and because past performance is not always an indicator of future results, we should not rely only on this measure to assess trading strategies. Tuesday, April 13, 201010
- 36. Numerical Ex:
- 37. 12 Monthly Average Return of 11.00%
- 38. 12 Monthly Average Return volatility of 4.00%
- 39. Weighted Average 12 monthly Risk free rate is 6.00% (Assume 3 Month US T-BILL Yields)
- 40. What is the SR – Sharpe Ratio ?Tuesday, April 13, 201011
- 41. Answer in MS XLS:
- 42. =SQRT12 *(11.00% - 6.00%)/SQRT(12)* 4.00%= 1.25Tuesday, April 13, 201012