Shortfall Risk

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FrankCFA

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I saw the pass exam use E(R) - 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(R) - 5 * standard deviations.
 
Good question; I recognized the formula E(R) - 2sigma, too, but also did not see it in the CFA curriculum.
 
Not to derail the question but isn’t shortfall risk Roy’s saftey first criterion?
Er - MAR / standard deviation?
 
Galli wrote:
Not to derail the question but isn’t shortfall risk Roy’s saftey first criterion?
Er - MAR / standard deviation?
Click to expand...
- Yes “The oldest shortfall risk criterion is Roy’s safety first criterion” - pg. 54, RR 18. Asset Allocation
 
FrankCFA wrote:
I saw the pass exam use E(R) - 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(R) - 5 * standard deviations.
Click to expand...
On pg. 54 of reading 18 - Asset Allocation, you find a write up under example 4 that identifies the method of using E(r) - 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.
 
Guys - if you are talking about the 2013 exam question… states so in the write up leading to the question
Quote:
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.
Click to expand...
 
^CPK, does that mean this approach is no longer in the latest curriculum?
 
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
 
On pg. 54 of reading 18 - Asset Allocation, you find a write up under example 4 that identifies the method of using E(r) - 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….
 
2014 curriculum - Shortfall risk is on Pg 194 under example 4 ….
 
FrankCFA wrote:
On pg. 54 of reading 18 - Asset Allocation, you find a write up under example 4 that identifies the method of using E(r) - 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.
Click to expand...
Thanks. But Reading 18 starts from p.175 (Curriculum)? Can’t find it….
[/quote]
My appologies - I was using the EBook.
 
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.
 
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