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FRM Part II · FRM Exam Part II · Portfolio Performance Evaluation

An analyst reports a manager's alpha of 2% per year with a standard error of 1.5% from 60 monthly observations. Which conclusion is most appropriate?

The t-statistic is about 1.33 (2% divided by 1.5%), below the roughly 2.0 needed for 5% significance, so skill is not statistically established. A positive estimated alpha could easily arise from luck given the estimation noise in 60 observations.

  1. AThe alpha is statistically significant at the 5% level because it is positive
  2. BThe alpha has a t-statistic of about 1.33, so skill is not established at conventional significanceCorrect
  3. CThe alpha has a t-statistic of 3.0, indicating strong skill
  4. DThe alpha proves luck, since the standard error exceeds zero

Explanation

t = 2/1.5 = 1.33, below the roughly 2 needed for 5% significance. A positive point estimate alone does not demonstrate skill, as noise could generate it. Claiming 3.0 miscomputes the ratio.

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