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KIC000038 - The Security Characteristic Line The Security...

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The Security Characteristic Line Excess Return on Asset • Characteristic Line '\ Beta for the firm is the slope of this line. -s-; Jensen Alpha for the firm is the intercept of this line. Excess Return on Market Total Risk = Systematic + Fund-Specific • How are the two types of risk related? Taking variances ... Y=a+p.%+e Var(Y) = Var(a) + Var(f3X) + Var(e) ai = f32a~ + a; TSS = RSS + ESS Percent of total risk that is systematic p 2 0-i, = RSS = R 2 P'o-~ +0-; TSS 0-; = ESS = l-R' p20-~+0-; TSS Percent of total that is fund -specific Performance Measures • There are several performance measures that may be used to compare or rank portfolios: • Sharpe ratio • Treynor ratio • Jensen's alpha • Appraisal ratio· • M2 • The choice of the most appropriate measure is generally dependent upon the circumstances involved. The Security Characteristic Line • The percentage of total variance being captured by beta (in other words the portion of total risk that is systematic) is given by the R 2 statistic of the regression. This gives an
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