Ch.21 Q10 and 11 – Textbook Solutions
10. We need to distinguish between market timing and security selection abilities. The intercept of
the scatter diagram is a measure of stock selection ability. If the manager tends to have a
positive excess return even when the market’s performance is merely “neutral” (i.e., has zero
excess return) then we conclude that the manager has on average made good stock picks. Stock
selection must be the source of the positive excess returns.
Timing ability is indicated by the curvature of the plotted line. Lines that become steeper as you
move to the right of the graph show good timing ability. The steeper slope shows that the
manager maintained higher portfolio sensitivity to market swings (i.e., a higher beta) in periods
when the market performed well. This ability to choose more market-sensitive securities in
anticipation of market upturns is the essence of good timing. In contrast, a declining slope as
you move to the right means that the portfolio was more sensitive to the market when the
market did poorly and less sensitive when the market did well. This indicates poor timing.
We can therefore classify performance for the four