Appraisal ratio
Jensen's alpha divided by the volatility of the residual, non-systematic return: the abnormal return earned for each unit of the unsystematic risk taken to earn it.
Where you will meet it
Appraisal ratio appears in 3 learning outcomes on the CFA syllabus. A few of them:
- Explain how a misspecified benchmark distorts attribution and appraisal analysis
“In attribution, style differences surface as spurious allocation or selection effects; in appraisal, alpha, the information ratio and the appraisal ratio are biased, and a portfolio beta far from the benchmark's distorts risk adjustment.”
- Compute and interpret maximum drawdown, drawdown duration, upside and downside capture ratios, the appraisal ratio and the Sortino ratio
“The appraisal ratio = alpha ÷ standard deviation of residual returns, rewarding alpha per unit of non-systematic risk.”
- Explain where appraisal measures and associated metrics fall short
“The Treynor ratio, Jensen's alpha and the appraisal ratio depend on the chosen benchmark or factor model: a wrong market proxy mis-estimates beta and therefore alpha.”
See also
Practise it
Practise appraisal ratio until it is automatic: questions that explain every wrong option.
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