ADMS 4501 Lecture Notes - Lecture 5: Sharpe Ratio, Systematic Risk, Scatter Plot

• School: York University
• Department: Administrative Studies
• Course: ADMS 4501
• Professor: Lois King

Document Summary

Ch. 21 q10 and 11 textbook solutions: 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 retur(cid:374) e(cid:448)e(cid:374) (cid:449)he(cid:374) the (cid:373)arket"s perfor(cid:373)a(cid:374)ce is (cid:373)erely (cid:862)(cid:374)eutral(cid:863) (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.