Market Fragmentation
Market fragmentation implies that a market is composed of several heterogeneous segments. Fragmentation in a market can be caused by several market needs, reduced levels of innovation, and economies of scale. Market fragmentation enables businesses to reach the right consumers….
Electronic Trading Systems
The electronic trading system involves the use of modern information technologies in business. Most large markets use electronic devices in their transactions to enhance efficiency and sufficiency. In such markets, traders and exchange systems are interdependent. While traders need fast…
Implementation Shortfall
The implementation shortfall approach involves taking the difference between the prevailing price and the final execution price when a buy or sell decision is made concerning security. This technique solves the challenges of the effective spread method. It consists of…
Implicit Costs Estimates
Trade prices are compared to the benchmark price to compute the implicit transaction costs. The benchmarks used are the effective spread, implementation shortfall, and VWAP techniques of cost evaluation. Effective Spread The effective spread is a measure of trading costs….
Execution Costs
Execution costs are vital in the provision of favorable portfolio management. They consist of fixed and variable costs. A fixed cost is an expense that remains constant in spite of changes in the volume of investment. In contrast, variable cost…
Strengths and Limitations of Fundamental Law
Strengths of Fundamental Law As discussed in the previous section, the fundamental law of active management can be employed in sectors such as security selection, sector rotation, and market timing. Limitations of Fundamental Law I. Ex-ante Skill Measurement The information…
Active Management Strategies
The active approach of selecting and managing stocks in a portfolio is composed of: Security selection. Sector analysis. Market timing. I. Security Selection Security selection involves choosing stocks that are expected to offer superior risk-return characteristics. An investor with a…
Application of the Information Ratio
An optimal portfolio can be obtained by combining a risk-free asset with an optimally risky asset portfolio. The optimally risky asset portfolio is the point where the capital allocation line is tangent to the efficient frontier. The optimal portfolio is…
The Fundamental Law of Active Portfolio Management
The Basic Law (Unconstrained Portfolio) The basic fundamental law of active portfolio management states that the optimal expected active return is the product of the assumed information coefficient (IC), the square root of breadth (BR), and the active portfolio risk….
Information and Sharpe Ratios
Information Ratio The information ratio (IR) is the proportion of the active return to the volatility of the active returns, also known as the active risk. It measures a portfolio’s risk-adjusted rate of return. The information ratio (IR) of an…
