The standard deviation of the difference between a portfolio's return and its benchmark's. It measures how far a portfolio strays from its benchmark.
Where you will meet it
Tracking error comes up in 12 learning outcome notes across the FRM syllabus.
A few of them:
Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM) FRM Part I · Foundations of risk management
“Tracking error is the standard deviation of the active return, portfolio minus benchmark.”
VaR Mapping FRM Part II · Market risk measurement and management
“Tracking error volatility uses the covariance matrix Σ of the risk factors, written TEV = √(x′Σx).”
Alpha (and the Low-Risk Anomaly) FRM Part II · Risk management and investment management
“Tracking error is the standard deviation of the active return, meaning portfolio return minus benchmark return, so it measures how far the portfolio strays from its benchmark.”
Alpha (and the Low-Risk Anomaly) FRM Part II · Risk management and investment management
“Expected alpha is then the information ratio times the tracking error, written TE, which is the active risk taken: Alpha = IR × TE.”
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