FRM Part II · FRM Exam Part II · VaR and Risk Budgeting in Investment Management
A manager's IC is 0.05 with 100 independent bets, giving IR of 0.50. The manager redesigns the process so that the same forecasts are now split into 400 bets, but analysis shows the bets are heavily correlated and the effective number of independent bets is only 144. Holding IC constant, what is the resulting IR?
The information ratio is 0.60. Breadth must reflect independent bets only, so the effective 144 bets are used: 0.05 times the square root of 144, which is 12, equals 0.60, rather than the overstated 1.00 from 400 bets.
- A1.00
- B0.60Correct
- C0.25
- D2.00
Explanation
Only independent bets count as breadth. IR = 0.05 x sqrt(144) = 0.05 x 12 = 0.60. Using 400 would give 1.00, which overstates breadth by counting correlated bets.
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