Information ratio from skill and breadth

Question

A forecasting signal has an information coefficient (IC) of 0.05, the correlation between its forecasts and realized returns, and you make 100 independent bets per year.

What annualized information ratio does this imply?

Accepted Answer

What these terms mean. The information ratio (IR) is just the Sharpe ratio of a strategy's active returns: how much excess return you earn per unit of active risk. The Fundamental Law of Active Management (Grinold) says the IR is built from two ingredients: IR = IC 	imes \sqrt{BR}, where the information coefficient (IC) measures skill per bet (the correlation between your forecast and the outcome, typically small, 0.02 to 0.10) and the breadth (BR) is the number of independent bets you make per year. In plain terms: a little skill, applied across many independent bets, compounds into a good …

Information ratio from skill and breadth

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