Alternative Investments: CAIA Level I, 3rd Edition

CHAPTER 5 Measures of Risk and Performance

Foundational concepts in alternative assets include risk measurement and performance analysis.

5.1 Measures of Risk

Standard deviation of returns, also known as volatility, is the most common measure of total financial risk. If the return distribution is a well-known distribution such as the normal distribution, then the standard deviation reveals much of or even all of the information about the width of the distribution. If the distribution is not well-known, then standard deviation is usually a first pass at describing the dispersion. However, standard deviation can be an ineffective measure of risk when a distribution is nonsymmetrical. Standard deviation incorporates dispersion from both the right-hand side (typically profit) and the left-hand side (typically loss) of the distribution. The two sides are identical in a symmetrical distribution, but in a nonsymmetrical distribution the sides differ; and in the case of risk, the analyst is primarily concerned with the left, or downside, half of the distribution.

The following section includes risk measures that focus on the left or loss side of the return distribution, as well as other popular measures. This section is not intended as a comprehensive listing; it does not discuss the computation of systematic risk measures (betas) or other less frequently used measures.

5.1.1 Semivariance

Some risk measures focus entirely on the downside of the return distribution, meaning that ...