Shortfall Risk

[FrankCFA]

I saw the pass exam use E® - 2 * standard deviations to meausre the shortfall risk. But i don’t find it in CFA curriculum. Is it usually the case? Or different risk tolerence has different scale number, i.e. maybe E® - 5 * standard deviations.

[JJ1337]

Good question; I recognized the formula E® - 2sigma, too, but also did not see it in the CFA curriculum.

[Galli]

Not to derail the question but isn’t shortfall risk Roy’s saftey first criterion?

Er - MAR / standard deviation?

[Enemyofmyenemy]

@Galli

Not to derail the question but isn’t shortfall risk Roy’s saftey first criterion?

Er - MAR / standard deviation?

• Yes “The oldest shortfall risk criterion is Roy’s safety first criterion” - pg. 54, RR 18. Asset Allocation

[Enemyofmyenemy]

@FrankCFA

I saw the pass exam use E® - 2 * standard deviations to meausre the shortfall risk. But i don’t find it in CFA curriculum. Is it usually the case? Or different risk tolerence has different scale number, i.e. maybe E® - 5 * standard deviations.

On pg. 54 of reading 18 - Asset Allocation, you find a write up under example 4 that identifies the method of using E® - 2 st. devs to calculate a particular shortfall risk. In particular, they specify -2 stdev’s as representing a 2.5% probability of falling below the expected return. The key here is the normality assumption. Hope this helps.

[cpk123]

Guys - if you are talking about the 2013 exam question… states so in the write up leading to the question

They indicate that the portfolio should have only a small probability of declining more than 10% in nominal pre-tax terms in any one year. Lenard explains to the Voorts that a normal distribution can be used to model the portfolio returns. The Voorts agree to use a two-standard-deviation approach to monitor the shortfall risk of the portfolio.

[Galli]

^CPK, does that mean this approach is no longer in the latest curriculum?

[cpk123]

What I meant to say was - if they want you to use Shortfall Risk approach - they will define the level of standard deviations (2 as in the above).

You need to know the definition of Shortfall risk.

but what kind - and what level - should be provided. If it is not provided - include the proviso - assuming a 2 standard deviation approach to Shortfall risk ---- shortfall risk is … and you should get the points

[Galli]

great, thanks

[FrankCFA]

On pg. 54 of reading 18 - Asset Allocation, you find a write up under example 4 that identifies the method of using E® - 2 st. devs to calculate a particular shortfall risk. In particular, they specify -2 stdev’s as representing a 2.5% probability of falling below the expected return. The key here is the normality assumption. Hope this helps.

[/quote]

Thanks. But Reading 18 starts from p.175 (Curriculum)? Can’t find it…

[zulu007]

Thanks.

[cpk123]

2014 curriculum - Shortfall risk is on Pg 194 under example 4 …

[Enemyofmyenemy]

@FrankCFA

On pg. 54 of reading 18 - Asset Allocation, you find a write up under example 4 that identifies the method of using E® - 2 st. devs to calculate a particular shortfall risk. In particular, they specify -2 stdev’s as representing a 2.5% probability of falling below the expected return. The key here is the normality assumption. Hope this helps.

Thanks. But Reading 18 starts from p.175 (Curriculum)? Can’t find it…

[/quote]

My appologies - I was using the EBook.

[FrankCFA]

Got it. Thanks.

Quote from CFA Curriculum: Given a normal distribution of returns, the probability of a return that is more than two standard deviations below the expected return is approximately 2.5 percent. Therefore, if we subtract two standard deviations from a portfolio’s expected return and the resulting number is above the client’s return threshold, the resulting portfolio passes that shortfall risk test.