A small edge over 400 bets: what information ratio?

Question

A forecasting signal has an information coefficient (IC) of 0.03, and you make 400 independent bets per year. What annualized information ratio does this imply?

Accepted Answer

The Fundamental Law. The information ratio (the Sharpe of active returns) is skill times the square root of breadth: IR = IC 	imes \sqrt{BR}, where IC is the correlation between forecast and outcome (skill per bet) and BR is the number of independent bets per year. Plug in the numbers. With IC = 0.03 and BR = 400: IR = 0.03 	imes \sqrt{400} = 0.03 	imes 20 = 0.6. Interpretation. Even a very weak signal (IC of 0.03, meaning the forecast barely correlates with outcomes) delivers a respectable information ratio of 0.6 when applied across 400 independent bets. This is the core promise of syste…

A small edge over 400 bets: what information ratio?

Your answer

More Statistics questions