Information coefficient
The correlation between a manager's forecast and realised active returns, the measure of skill. Even a small positive value can be worth a lot when applied across many independent decisions.
Where you will meet it
Information coefficient appears in 5 learning outcomes on the CFA syllabus. A few of them:
- Set out and explain the fundamental law of active management for portfolios and each of its terms: breadth, the information coefficient, the transfer coefficient, and active risk (aggressiveness)
“The information coefficient is the correlation between forecast and realised active returns, the measure of skill.”
- Set out the steps by which a quantitative active equity strategy is developed
“The signal is then back-tested: stocks are ranked each period, the information coefficient between scores and next-period returns is measured, and returns of top and bottom quintiles are compared.”
- Contrast active strategies such as security selection and market timing, and use active management's fundamental law to assess shifts in strategy
“A market timer makes a few calls a year on broad asset classes, so breadth is small and a high information coefficient is needed.”
- Set out where active management's fundamental law is useful in practice and where it falls short
“The information coefficient is an ex ante estimate that must be inferred from a noisy track record and may change over time.”
See also
Practise it
Practise information coefficient until it is automatic: questions that explain every wrong option.
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