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Whew! You're measuring the performance of your portfolio by the Sharpe
Ratio, right. Implicitly all open positions are in your portfolio, so how
can you miss anything as you seem to be saying? If a position is closed it's
no longer in your portfolio, but that doesn't change the way you measure the
performance of your portfolio. Externally, you can also measure the
performance of individual stocks in which you're not perhaps temporarily
holding a position, but that isn't relevant to the measurement of the
portfolio.
Colin West
-----Original Message-----
From: Bengtsson, Mats [mailto:mats.bengtsson@xxxxxxxx]
Sent: Saturday, August 10, 2002 1:35 PM
To: Bob Fulks
Cc: omega-list@xxxxxxxxxx
Subject: RE: A complicated (for me) question on protfolio calculations
Ok, yes I am convinced, I need to put the capital into the picture. I will
do that. But my main question remains the question on the best way to handle
stocks not represented on a certain day, when there are other stocks in the
portfolio represented that day.
> In your case, you should calculate the return each day on the
> amount at risk each day and you will find that you will get
> the right answers.
To me, the above is the tricky part. I try to do what is stated above, but
ask the question on how to do when I do not always have all trades
represented each day for the stocks included in my portfolio (and I do
calculations on portfolio level). To calculate standard deviation, I need to
look at each and every days summed equity at close. Some days have more
stocks in trade than others. But, the ones not being traded are still at
risk. Those are the ones I need help on how to handle, what should I use in
the calculations as that days equity on them? How do I handle the lack of
knowledge the best?
Example: Stock A trades day 1,2 and 3 so it is included in the portfolio for
all portfolio days. Stock B trades only day 1 and 3. So when looking at
calculating a Sharpe value for two stocks traded three days, I have to
decide on how to handle stock B day 2 because I have no knowledge of its
value. Thus I have to decide on calculation method as my alternatives below
states, and this is here I am lost.
Alternative 1: I could guess that the value of Stock B day 2 was same as day
1, and then calculate portfolio changes based on two stocks, with equity at
close known for all three days and using those days when calculating average
and standard deviation. This is doing a calculation based on one possible
assumption on stock value for stock B. Not good, but better than my current
method which is alternativ 2 below.
Alternative 2: I could say that stock B was not represented day 2, meaning
that there was no value explicitly stated for it as an equity at close,
meaning that it had value zero since no one bought it that day. My standard
deviation on that portfolio will be quite high, since one stock is
recognised as worthless day 2. This is what I do today, but looking at the
results, this does not seem to give fair values, good trading systems
sometimes get high standard deviations without good cause.
Alternative 3: I could say that I know nothing about stock B for day 2 and
that it should thus not be affecting the calculation more than the other
stocks that day (sort of saying if they go up, it goes up, if they go down,
it goes down). In the calculation I could do that by saying that day 1, the
others had an equity on average of... Day 2 they had an average of ... The
difference in those averages are then assumed to be the difference in equity
also for stock 2. And the portfolio value day 2 is thus value of stock A day
2 plus the assumed value of stock B day2. Once again taking a guess at value
of stock B which affects calculations by an assumption, but it seems better
than basing it on the assumption of stock B becomig worthless now and then
(since all trades are closed out eventually, stock B where never really
worthless).
Alternative 4: Well, the only alternative I know of that is left is using
the averages of equity for all stocks represented each day. This will
represent stock B for day 2 with the value of stock A (Portfolio equity day
1 is average of stock A and stock B times two, Portfolio value of day 2 is
value of stock 1 times 2). This was my first guess on what alternative would
be better than alternative 2, but I now see it is not good.
Is there a better alternative? If not, which of the 4 above is the best?
Clearly alternative 2 is taking the least assumptions but also paying
unneccessary high tributes to days when a certain stock is not traded.
> -----Original Message-----
> From: Bob Fulks [mailto:bfulks@xxxxxxxxxxxx]
> Sent: den 10 augusti 2002 20:45
> To: Bengtsson, Mats
> Cc: omega-list@xxxxxxxxxx
> Subject: Re: A complicated (for me) question on protfolio calculations
>
>
> You are not accounting for all the factors in your calculation.
>
> Consider that you have a $200,000 account.
>
>
> Case 1 - Invest $20,000
>
> In this case you invest only $20,000 of the account and
> achieve a 20% return on that investment = $4,000. Assume that
> the standard deviation of those returns is 15% or $3,000.
>
> Assume you invest the remaining $180,000 at the risk-free
> rate of 3% for a $5,400 return with zero standard deviation.
> Thus, the Sharpe Ratio of the portfolio is:
>
> Sharpe = (Return - Risk_free_return) / Standard_deviation
> = (4000 + 5400 - 3% of 200000) / 3000
> = 3400 / 3000 = 1.13
>
>
> Case 2 - Invest $200,000
>
> In this case you invest all $200,000 in the same investment
> and achieve the same 20% return on that investment = $40,000.
> Assume that the standard deviation of those returns is again
> 15% or $30,000.
>
> Sharpe = (Return - Risk_free_return) / Standard_deviation
> = (40000 - 3% of 200000) / 3000
> = 34000 / 30000 = 1.13
>
> So we see that the Sharpe Ratio of the overall portfolio is
> THE SAME IN EITHER CASE!
>
> That is one of the advantages of using the Sharpe Ratio - it
> measures the return-to-risk ratio. In both of the above
> cases, the excess return (return in excess of the risk-free
> rate) was proportional to the risk, so the Sharpe Ratio of
> the resulting portfolio is independent of what percentage of
> the portfolio you invest.
>
> It measures the Sharpe Ratio of the investment itself and is
> independent of how much money you invest in it.
>
> If the investment is a trading system, for example, the
> Sharpe Ratio measures the performance of the trading system,
> independent of the trade-size. (Caveat: if trade size gets
> very large - near the so-called "Vince optimal_F point" - the
> relationship ceases to be linear and the Sharpe Ratio begins
> to decrease as the trade size increases, [but only an idiot
> would use trades that large...])
>
> In your case, you should calculate the return each day on the
> amount at risk each day and you will find that you will get
> the right answers.
>
> Bob Fulks
>
>
> At 3:02 PM +0200 8/10/02, Bengtsson, Mats wrote:
>
> >From this list I have learned to trust the Sharpe-value. The
> >calculation behind it seems fair, but yet, when looking at
> the results
> >I get usig it compared to Kelly value and other figures, I realise I
> >have to change the portfolio calculation.
> >
> >The problem seems to lie in the assumptions behind my own portfolio
> >calculations, and thus I need advise on how to adjust the
> calculations.
> >If i do the calculations on only one stock everything is
> fine. What is
> >happening is that on some shorter days there are a lot less
> trade than
> >on longer days, and on some days by pure chance some less
> traded stocks
> >are not traded at all. The portfolio calculation translates
> this to a
> >risk using the Sharpe value, which is fair, but looking at it I see
> >that the risk is overestimated in strategies using fewer buys than
> >strategies using many buys.
> >
> >My guess is that this can be remedied by using equity per stock for
> >each day in the calculation instead of just equity as is
> done now. My
> >question is if I am right, and if not what else to do.
> >
> >Below is an explanation of the calculation at what I consider as the
> >wring assumption.
> >
> >Date Equity Number of stocks Equity per stock
> >990119 280000 303 924
> >990121 260000 281 925
> >990122 283000 305 928
> >990123 261000 281 929
> >
> >As can se above, when calculating Sharpe ration based on
> equity change
> >from day to day, the value will go up and down (-20000 first day,
> >+23000 next day, minus 21000 thirs day, ...). This is how the
> >calculation is done today, giving a low sharpe ratio in the
> end. If I
> >instead would calculate the risk based on changes in equity
> per stock
> >included in the measure, I would get a much smoother curve.
> >
> >It can be argued that the risk is higher since the trades include
> >stocks that by some reason do not trade each and every day, thus the
> >Sharpe ratio shall swing more. I can accept that as the truth, but I
> >prefer to view that as a micro-level calculation which is to be
> >considered and remedied when creating the trading systems
> and trading
> >them, not a macro level assumption that shall result in such
> swings in
> >the portfolio Sharpe calculation as it does. Instinctively I
> feel that
> >using the equity per stock should be a much fairer result
> than equity
> >that is travelling up and down just because some stocks do not trade
> >same days as others (this will always be the case when trading
> >international markets, some markets will have holidays when
> others do
> >not).
> >
> >I would very much appreciate any help and input on this
> subjet. It is
> >from this list I have learned to trust the Sharpe ratio, now I would
> >like to have a little help in applying it better to Portfolio level
> >calculations than I do today.
> >
> >--- Mats ---
> >
> >
> >
>
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