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Bridge over ocean
1 July 2008 Financial Analysts Journal Volume 64, Issue 4

How Variation in Signal Quality Affects Performance

  1. Jia Ye

The information coefficient (IC), the correlation between forecasted and realized
return, is a popular measure of signal quality. As shown in this article,
variation in IC is an important source of active risk, and IC variation has an
effect on optimal portfolio structure. Contrary to popular belief, the ability
to take short positions in equity portfolios does not necessarily lead to
superior performance. Managers who can maintain a stable IC over time will
benefit from short extensions, but managers who have an unstable IC may see
their performance deteriorate from increased short positions.

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