IAI Actuarial Core Principles · Economic Modelling · Measures of investment risk
An investor in a pension fund is concerned only with the chance that the annual return falls below a target level of 6%. Which risk measure directly captures this concern?
Shortfall probability relative to 6% is correct because it measures the probability that the return falls below the target. Variance, standard deviation, correlation and beta do not isolate the chance of missing a specified threshold; the first two are symmetric and the others concern market relationships.
- AVariance of returns
- BShortfall probability relative to 6%Correct
- CStandard deviation of returns
- DCorrelation with the market portfolio
- Beta of the fund
Explanation
Shortfall probability is P(return < target), here P(R < 6%). Variance and standard deviation treat gains and losses symmetrically, while correlation and beta measure co-movement or market sensitivity, not the chance of missing a target.
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