ADMS 4501 Lecture Notes - Lecture 6: Risk Premium, Survivorship Bias, Capital Asset Pricing Model

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The dollar-weighted average return or irr for the cash flow given, based on daily compounding, is . 05553 percent or an annual rate of 22. 46 percent. (solved through spreadsheet by using xirr function, and assuming 365 days in a year. ) As established in the following result from the text, the sharpe ratio depends on both alpha for the portfolio ( market index ( ): ) and the correlation between the portfolio and the re. Specifically, this result demonstrates that a lower correlation with the market index reduces the sharpe ratio. Hence, if alpha is not sufficiently large, the portfolio is inferior to the index. The irr (i. e. , the dollar-weighted return) cannot be ranked relative to either the geometric average return (i. e. , the time-weighted return) or the arithmetic average return. Under some conditions, the irr is greater than each of the other two averages, and similarly, under other conditions, the irr can also be less than each of the other averages.

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