Please help me with this question. Thanks.
Which of the following performance measures is most appropriate for an investor who is not fully diversified?
- Treynor ratio.
- Jensen’s alpha.
A is the correct. M 2 adjusts for risk using standard deviation (i.e., total risk).
M^2 is an alternative to Sharpe ratio and they both use STANDARD DEVIATION ( i.e. total risk= standard deviation + beta )
standard deviation is also called as unsystematic risk which can be reduced by diversification.
Beta also called as systematic risk which cannot be reduced by diversification or any other way.
Therefore an investor should only be compensated for the risk he takes that i.e. he should only be compensated for beta not standard deviation (as it can be reduced through diversification)
Treynor ratio, Jensen’s alpha. calculate returns based on beta why? as I mentioned above .
M^2 and Sharpe ratio uses standard deviation which means that the portfolio is not diversified and is a concentrated portfolio