BB Q: tracking risk is 1%. Explain what 1% mean.
Solution: two-thirds of the time periods, smaller than 1% deviation vs. benchmark.
Why solution using two-thirds of time periods? Thanks.
If returns are normally distributed then about 68% (i.e. 2/3) of the values are within one standard deviation of the mean.
Tracking error = standard deviation of active returns.
Saying that tracking error is 1% means that, given normal distribution assumptions, we expect that
34.1% of the time portfolio active returns fall between 0% and 1%
and
34.1% of the time portfolio active returns fall between -1% and 0%.
34.1% + 34.1% ~ 68% ~ 2/3
Good luck, Carlo
Appreciated.