6/23/2024

Aman Singhania, CFA, FRM.

Aman Singhania, CFA, FRM.

Measure of Central Tendency

Measure of Central Tendency

Return (Average) Risk (Dispersion)

Statistical Concepts &

Market Returns Mean Median Mode

Range

Arithmetic Mean Absolute

Deviation
Weighted
Quantiles
Geometric

Standard dev
Harmonic
Presented by: Aman Singhania, CFA, FRM

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Aman Singhania, CFA, FRM.

Arithmetic mean Arithmetic mean - example

Assume you and your research assistant are evaluating the stock of XYZ Corporation. You have
Population Mean calculated the stock returns for over the last 12 years to develop the following data set. Your
research assistant has decided to conduct his analysis using only the returns for the five most
recent years, which are displayed as the underlined numbers in the data set. Given this
information, calculate the population mean and the sample mean.

Data set: 12%, 25%, 34%, 15%, 19%, 44%, 54%, 33%, 22%, 28%, 17%, 24%

Sample Mean

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Arithmetic mean - example Arithmetic mean - example

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Weighted mean Weighted mean - example

A portfolio consists of 50% common stocks, 40% bonds, and 10% cash. If the return on
Recognizes that different observations may have different weights common stocks is 12%, the return on bonds is 7%, and the return on cash is 3%, what
is the portfolio return?

Asset Weight Return Contribution

Common 50% 12% 6%

Stock
Bonds 40% 7% 2.8%

Cash 10% 3% 0.3%

Total 100% 9.1%

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Aman Singhania, CFA, FRM.

Weighted mean - example Geometric mean
A portfolio consists of 30% common stocks, 50% bonds, and 20% cash. If the return on
common stocks is -9%, the return on bonds is 6.5%, and the return on cash is 4%, The geometric mean is often used when calculating investment returns over
what is the portfolio return?
multiple periods or when measuring compound growth rates
Asset Weight Return Contribution
GM = [(1 + r1%) x (1 + r2%)…… x (1 + rn%)] (1/n) -1
Common 30% -9% -2.7%
Stock
Bonds 50% 6.5% 3.25%

Cash 20% 4% 0.8%

Total 100% 1.35%

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Geometric mean – example 1 Geometric mean – example 2

For the last three years, the returns for Ozone Corporation common stock have For the last three years, the returns for Acme Corporation common stock have been
been 5%, 6% and 7%. Compute the compound annual rate of return over the 3- -9.34%, 23.45% and 8.92%. Compute the compound annual rate of return over the 3-
year period. year period.

GM = [(1 + r1%) x (1 + r2%) x (1 + rn%)] (1/n) -1

GM = [(1 + r1%) x (1 + r2%) x (1 + rn%)] (1/n) -1

GM = [(1 + 5%) x (1 + 6%) x (1 + 7%)] (1/3) - 1 GM = [(1 + -9.34%) x (1 + 23.45%) x (1 + 8.92%)] (1/3) - 1

GM = [(1 + 0.05) x (1 + 0.06) x (1 + 0.07)] (1/3) - 1 GM = [(1 – 0.0934) x (1 + 0.2345) x (1 + 0.0892)] (1/3) - 1

GM = [1.05 x 1.06 x 1.07] (1/3) - 1 GM = [0.9066 x 1.2345 x 1.0892] (1/3) - 1

GM = [1.19091] (1/3) - 1 GM = [1.21903] (1/3) - 1

GM = 1.05996 – 1 = 0.05996 = 5.996% GM = 1.06825 – 1 = 0.06825 = 6.825%

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Harmonic mean Harmonic mean - example
An investor purchases $1000 of stock each month, and over the last three
The harmonic mean is used for calculating the average cost of shares over time.
months the prices paid per share were $8, $9, $10. What is the average
Applicable when one invests equal amount of money at regular intervals
cost per share for the shares acquired?

No of units collected
1st month = $1000/8 = 125
2nd month = $1000/9 = 111.11
3rd month = $1000/10 = 100
Total units collected = 336.11
Price per unit = $3000/336.11 = $8.926

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Median Median – example 1

The median is the midpoint of a data set when the data is arranged in What is the median return for five portfolio managers with 10 year
ascending or descending order. annualized total returns record of 30%,15%, 25%, 21%, and 23%?

Descending order
30%, 25%, 23%, 21%, 15%

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Median – example 2 Mode

Suppose we add a sixth manager to the previous example with a return of 28%. What is The mode is the value that occurs most frequently in a data set.
the median return?

30%,15%, 25%, 21%, 23% and 28%

Descending order
30%, 28%, 25%, 23%, 21%, 15%

Average of 25% and 23% = 24%

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Mode – example 1 Mode – example 2

What is the mode of the following data set? What is the mode of the following data set?

[30%, 28%, 25%, 23%, 28%, 15%, 5%] [30%, 28%, 25%, 23%, 28%, 15%, 5%, 15%]

Answer Answer

Mode = 28% Mode = 28% and 15% : Bimodal data

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Mean, Median and Mode – Application Measure of Central Tendency

When to use Mean, Median and Mode?

Measure of Central Tendency

Return (Average) Risk (Dispersion)

Mean Median Mode

Range

Arithmetic
Mean Absolute
Deviation
Weighted
Quantiles
Geometric

Standard dev
Harmonic

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Range Range - example

The range is the distance between the largest and the smallest value in What is the range for the 5year annualized total returns for five
the data set investment managers if the managers' individual returns were 30%,
12%, 25%, 20%, and 23%?
range = maximum value - minimum value

range = maximum value - minimum value

range = 30 – 12 = 18

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Mean Absolute Deviation (MAD) Mean Absolute Deviation (MAD) - example

What is the MAD for the 5year annualized total returns for five investment
The mean absolute deviation (MAD) is the average of the absolute values of managers if the managers' individual returns were 30%, 12%, 25%, 20%, and
the deviations of individual observations from the arithmetic mean. 23%?

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Quantiles Quantiles - example

Quantiles is the general term for a value at or below which a stated What is the third quartile for the following distribution of returns?
proportion of the data in a distribution lies. 8%,10%, 12%, 13%, 15%, 17%, 17%, 18%, 19%, 23%

Examples of quantiles include: Third quartile corresponds with 75%, so y = 75 and n = 10

Quartile : the distribution is divided into quarters
Quintile : the distribution is divided into fifths
Decile : the distribution is divided into tenths
Percentile : the distribution is divided into hundredths (percents)
8th observation = 18%
9th observation = 19%
The formula for the position of the observation at a given percentile ‘y’ So, 8.25th observation = 18.25%
with ‘n’ data points sorted in ascending order is:
This means that 75% of observations lie below 18.25%

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Box and Whisker Plot Variance and Standard Deviation

Variance is defined as the average of the squared deviations from the

mean

Population Variance Sample variance

To visualize a data set based on quantiles, we can create a box and whisker plot, as shown
in Figure. In a box and whisker plot, the box represents the central portion of the data, such
as the interquartile range. The vertical line represents the entire range. In above Figure, we
can see that the largest observation is farther away from the center than the smallest
observation is. This suggests that the data might include one or more outliers on the high
side.

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Standard Deviation Population Variance & Standard Deviation - example

Assume the 5 year annualized total returns for the five investment managers used in the
The standard deviation is the square root of the variance earlier example represent all of the managers at a small investment firm. What is the
population variance of returns?

annualized returns: [30%, 12%, 25%, 20%, 23%]

Population Standard
Deviation

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Sample Variance & Standard Deviation - example Risk-Return ratio

Assume the 5 year annualized total returns for the five investment managers used in the
earlier example represent only a sample of the managers at a large investment firm. Measure of Central Tendency
What is the sample variance and standard deviation of these returns?
Return (Average) Risk (Dispersion)
annualized returns: [30%, 12%, 25%, 20%, 23%]

Mean Median Mode

Range

Arithmetic Mean Absolute

Deviation
Weighted
Quantiles
Geometric

Standard dev
Harmonic
A B
Return 2% 4%
Risk 5% 11%

1. Coefficient of variation (CV)

Sample Standard
Deviation

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Coefficient of variation (CV) Coefficient of variation (CV) - example

CV is a ratio of risk to return You have just been presented with a report that indicates that the mean monthly return
on T- bills is 0.25% with a standard deviation of 0.36%, and the mean monthly
return on the S&P 500 is 1.09% with a standard deviation of 7.30%. Your unit manager
has asked you to compute the CV for these two investments and interpret your results.

T-bills S&P 500

Return 0.25% 1.09%

Risk 0.36% 7.30%

CV =0.36/0.25 = 1.44 =7.30/1.09 = 6.70

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Limitations of the Sharpe ratio
Sharpe Ratio

Sharpe ratio is the ratio of excess return to risk Limitations of the Sharpe ratio

Sharpe ratio = Ra – Rfr 1. If two portfolios have negative Sharpe ratios, it is not necessarily true that the
a higher Sharpe ratio implies superior risk-adjusted performance. Increasing risk
moves a negative Sharpe ratio closer to zero (i.e. higher)

For example 2. The Sharpe ratio is useful when standard deviation is an appropriate measure
Return on an asset = 8% of risk.
Risk free rate = 3%
Standard Deviation = 10%

Sharpe ratio = 8% – 3% = 5/10 = 0.5

10%

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Normal Distribution Skewness

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Kurtosis Kurtosis - Leptokurtic

excess kurtosis = sample kurtosis - 3

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