Measuring Performance in a Dynamic World: Conditional Mean-Variance Fundamentals
Posted: 5 May 2006 Last revised: 25 Nov 2013
Date Written: June 30, 2006
We develop conditional alpha performance measures that are consistent with conditional mean-variance analysis. Commonly employed conditional alpha measures are inconsistent with conditional mean-variance analysis, conditional Sharpe ratio maximization, the magnitude or sign of the true conditional alphas, and reliable time-varying alphas. This conclusion is based on our derivation of the conditional investment opportunity set and its implied conditional alphas for given population parameters. The analysis is not subject to estimation errors and the important issue of whether empirically estimated performance measures violate the bounds on rational stochastic discount factors (Chen and Knez, 1996). An empirical example demonstrates that the differences between existing measures and our proposed measures are substantive for typical parameterizations.
Keywords: Conditional Performance Measurement, Conditional Jensen's Alpha, Conditional Sharpe Ratio, Conditional Appraisal Ratio, and Conditional Mean-Variance Analysis
JEL Classification: G13, G23
Suggested Citation: Suggested Citation