IAI Actuarial Core Principles · Economic Modelling · Measures of investment risk
An investor wants a risk measure that captures only the possibility of returns falling below a minimum acceptable level, and ignores variability of returns above that level. Which measure best suits this aim?
Downside semi-variance about the target return is the best choice. It counts only squared shortfalls below the minimum acceptable return and ignores deviations above it, whereas variance and standard deviation penalise upside and downside movements equally.
- AVariance of returns
- BStandard deviation of returns
- CDownside semi-variance about the target returnCorrect
- DRange of returns
- Coefficient of variation
Explanation
Semi-variance about a target squares only the shortfalls below the target, so upside deviations are ignored. Variance and standard deviation treat upside and downside deviations equally, and the range and coefficient of variation also do not isolate shortfall below a target.
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