Financial Risk Manager Part 1

Explanation

The Information Ratio (IR) is the correct measure to use in this scenario because:

• IR = Active Return / Tracking Error
• It evaluates whether the portfolio manager's deviation from the benchmark has generated appropriate returns relative to the additional risk taken
• A high IR indicates that the manager has successfully generated excess returns that justify the deviation risk
• A low IR suggests the deviation hasn't produced sufficient returns to compensate for the additional risk

Why other options are incorrect:

A. Tracking Error: Only measures the standard deviation of active returns (risk of deviation), but doesn't assess whether the returns justify this risk

C. Sortino Ratio: Focuses on downside risk specifically and doesn't measure performance relative to a benchmark

D. Jensen's Alpha: Measures excess returns relative to CAPM expectations, but doesn't directly compare performance to a specific benchmark portfolio

The Information Ratio is specifically designed to answer the question: "Has the manager's deviation from the benchmark produced returns that appropriately compensate for the additional risk taken?"