TC transfer coefficient

Can anyone help explain this formula?

TC = corr(acive_return/sigma , weights * sigma)

i’m trying to wrap my head around how this formula relates to the intuitive definition of TC being “actual weights vs. optimal weights”. The formula doesn’t seem to equate to that

I just did a quick Excel calculation and concluded that it doesn’t relate to the definition at all.

I think the link is that the equation for optimal weights uses the active returns and forecasted volatility. Specifically, look at the formula for the mean-variance optimal active weights.

Too deep for me… this question WILL not be on the exam :slight_smile:

but one of the EOC questions use that to solve for the transfer coefficient so i just wanted to know what the intuition behind this formula is otherwise i’ll just be memorizing yet another formula

Yea I ain’t memorizing that. All I know is TC is the ability to convert forecasted active returns into weights and that TC =1 for unconstrained portfolios, and <1 for constrained portfolios. If this shows up on the exam, I’ll take it as 3 minutes gained for other questions.