3 - Statistical Concepts - Market Returns

Statistical Concepts And Market Returns
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Introduction
Statistical methods are powerful tools to analyze data and draw useful
conclusions from the same
Statistical methods are used to summarize return distributions eg. Asset
returns, earnings growth rates, stock prices, etc.
Following four properties can be explored
❑ Where are the returns centered (Central Tendency)
❑ How far are the returns dispersed from their center (Dispersion)
❑ Whether the returns distribution is symmetrically shaped or
lopsided (Skewness)
❑ Whether extreme outcomes are likely (Kurtosis)
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Nature of Statistics
• Summarize large data sets into useful information.

The last 3 year annualized Descriptive • All measures of central tendency, dispersion,
returns on the equity shares Statistics skewness and kurtosis fall under this branch of
of Reliance Industries are statistics
10%, 14% and 9%. So the
average 3-year return is 11%.
Estimates suggest that equity
shares of Reliance Industries
will grow 10% more than the • Making forecasts, estimates and judgment for a
last 3-year return, so the Statistical larger group using a small group actually observed.
projected return for coming 1 Inference • Probability theory is the basis for the statistical
year would be 12.10% (11% + inference methods
10% of 11%).

Populations and Sample
Population – All members of a specified sample

❑ Parameter – A descriptive measure of a population characteristic
Sample – It is a subset of a population. Certain people
❑ Sample Statistic – Quantity computed to describe a sample with Hyundai
cars (sample)
Example:
❑ You are a telecom analyst and would want to know the average
usage by customers of a particular locality
❑ In this case all the people using the phone in that locality becomes
your population.
❑ Average usage by customers is your parameter
❑ It is a huge coverage, so you decide to select 50 people and take
data from them. These 50 people become your sample.
❑ The mean usage of these 50 people lets say works out to 520 Total number of car owners
minutes a month. This is a sample statistic. in India (Population)

Measurement Scales
• Categorize but not rank data

• Example - Qualification of mutual funds based on investment style – Large cap, small cap or
Gender Nominal
distinction between sector funds and balanced funds
Scale
• Sorts data and ranks the data points, however it does not differentiate between successively
Position ranked data points
• Example - Mutual fund ratings issued by MorningStar or ValueResearchonline. They provide
in a Ordinal
performance in star ratings. No clear performance differentiation is mentioned between a fund
match Scale
receiving 5 stars versus the one getting 4 stars
1st 2nd 5th
• Ranks data and the difference between the scale values is equal. It does not have a true zero
value
Thermometer • Example - Celsius scale for measurement of temperature is an interval scale. Difference between
Interval
19o and 20o is just 1 degree which is the same for any other scale values However 0o does not
Scale
mean an absence of temperature
• Ranks data and the difference between the scale values is equal. Also it has a true zero value.
Money • Example - Rate of returns is measured using a ratio scale. If our money doubles → rate of return is
Ratio 100%, if our money doesn’t grow → rate of return is 0%. A perfect zero, an actual absence of
Scale returns.

Identify the type of Measurement Scales
Credit Ratings for

• Ordinal Scale
bond Issues
Cash Dividends per

• Ratio Scale
share
Hedge Fund
• Nominal Scale
classification types
Bond maturity • Ratio Scale

Frequency Distribution
Frequency distribution – tabular display of data summarized into

relatively small number of intervals
Steps to construct a frequency distribution
❑ Sort the data in ascending order
❑ Calculate the range of data, range = Maximum – Minimum value
❑ Decide the number of intervals, k
❑ Calculate the interval width as Range / k
❑ Determine the intervals by successively adding the interval width,
starting with the minimum value
❑ Count number of observations falling in each interval
❑ Display data in a tabular manner

Frequency Distribution
Relative frequency – Is the absolute frequency of each interval divided by the

total number of observations
Cumulative relative frequency – Cumulates the relative frequencies as we
move from first to last interval
Histogram – Is a bar chart of data that have been grouped into the frequency
distribution
Frequency polygon – Graph joining the midpoints of each interval on the x-
axis and absolute frequency for that interval on the y-axis
Cumulative Frequency Distribution – Frequency polygon when plotted with
cumulative frequencies as we move from first to last interval is called as a
cumulative frequency distribution

Example – Frequency Distribution
Compute the frequency distribution for the given set of data

Real Equity Returns (1900-2000)
Country Arithmetic Mean
Australia 9.00%
Belgium 4.80%
Canada 7.70%
Denmark 6.20%
France 6.30%
Germany 8.80%
Ireland 7.00%
Italy 6.80%
Japan 9.30%
Netherlands 7.70%
South Africa 9.10%
Spain 5.80%
Sweden 9.90%
Switzerland 6.90%
United Kingdom 7.60%
United States 8.70%
Source: CFA Institute course material - Level 1

Source: Dimson, Marsh and Staunton (2002)

Solution – Frequency Distribution
Data in ascending order

Steps to building Frequency Distribution
Belgium 4.80% Range = 9% - 4.8% = 4.20%

Spain 5.80%
Denmark 6.20% k = 6
France 6.30%
Italy 6.80% Interval Width = round ( 4.2% / 6) = ~ 1%
Switzerland 6.90%
Ireland 7.00%
United Kingdom 7.60% Frequency Distribution
Canada 7.70%
Netherlands 7.70% Return Absolute Cumulative Absolute Relative Cumulative relative
United States 8.70% Interval Frequency Frequency Frequency Frequency
Germany 8.80% 4% to 5% 1 1 6.25% 6.25%
Australia 9.00% 5% to 6% 1 2 6.25% 12.50%
South Africa 9.10% 6% to 7% 4 6 25.00% 37.50%
Japan 9.30% 7% to 8% 4 10 25.00% 62.50%
Sweden 9.90% 8% to 9% 2 12 12.50% 75.00%
9% to 10% 4 16 25.00% 100.00%
Source: Dimson, Marsh and Staunton (2002) 1 frequency point adds 6.25% to the cumulative frequency (1/16 = 6.25%)

Solution – Frequency Distribution
Histogram
5
Return Absolute Cumulative Relative Cumulative
4 4 4
Interval Frequency Absolute Frequency Frequency relative Frequency 4
4% to 5% 1 1 6% 6.25%
5% to 6% 1 2 6% 12.50% 3
2
6% to 7% 4 6 25% 37.50% 2
7% to 8% 4 10 25% 62.50% 1 1
8% to 9% 2 12 13% 75.00% 1
9% to 10% 4 16 25% 100.00%
0
16
4% to 5% to 6% to 7% to 8% to 9% to
5% 6% 7% 8% 9% 10%
Cumulative Frequency Polygon Frequency Polygon

120% 30%
100% 25% 25% 25%
100% 25%
75%
80% 63% 20%
60% 15% 13%
38%
40% 10% 6% 6%
13% 5%
20% 6%
0% 0%
0% 0%
2% to 3% to 4% to 5% to 6% to 7% to 8% to 9% to 10% to11% to 4% to 5% to 6% to 7% to 8% to 9% to
3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 5% 6% 7% 8% 9% 10%

Measures of Central Tendency
Measures of Central
The 1-month returns for last 6 Measures of Location The 1-month returns for last 6
Tendency
months on the stock of Coffee months on the stock of Coffee
Day Enterprises are: Day Enterprises are:
8%, 12%, -2%, 5% and 15% 8%, 12%, -2%, 5% and 15%
Measures the
Where is the data location or
So the average or mean return is: centered? distribution of So the 25%th returns are located
7.60% between -2% and 5% (we’ll see
data the calculations in forthcoming
slides)
Central Tendency provides a Arithmetic Mean,

single number or range of Quartiles,
Mode, Median,
numbers which represents Quintiles, Deciles
certain characteristic of the Weighted Mean,
and Percentiles
population or sample. Geometric Mean

Arithmetic Mean
Definition:
❑ The arithmetic mean is the sum of the observations divided by the
number of observations.
❑ It can be calculated for both the population as well as the sample.
To Remember
✓Arithmetic mean is affected by large values – for instance the

mean for 6,7,8,9,10 is 8 but for 6,7,8,9,100 is 26. Just one
number can change the mean by significant number.

Arithmetic Mean…
Populations Mean:
❑ Always denoted by ‘µ’ (pronounced as ‘mew’)
❑ Formula
N
∑ Xi
µ = i=1
Sample Mean:
❑ Denoted by (read as X-bar)
N
❑ Formula X
n
X = i=1
∑ Xi
n

Example
Compute the arithmetic mean for the given set of data

Australia 9.00%
Belgium 4.80%
Canada 7.70%
Denmark 6.20%
France 6.30%
Germany 8.80%
Ireland 7.00%
Italy 6.80%
Japan Mean = 7.60%
9.30%
Netherlands 7.70%
South Africa 9.10%
Spain 5.80%
Sweden 9.90%
Switzerland 6.90%
United States 8.70%


Properties of the Arithmetic Mean
▪It is cenre of an object

▪Mean return is used as a measure of outcome for an asset by analyst
▪Deviation from mean Indicate risk
▪Deviation form the basis of skewness,kurtosis and variance
▪Affected by extreme values that is arithematic mean could be misleading

Median
Definition:
❑ The median is the value of middle item of a set of items that has
been sorted into ascending or descending order.
Formula:
❑ For odd number of observations
➢ Median occupies = (n + 1)/2 position
❑ For even number of observations
➢ Median occupies the mean of the n/2 and (n + 2)/2 position

Example
Compute the Median Value for the given set of data

Real Equity Returns (1900-2000) Real Equity Returns (1900-2000)
a) b)
Australia 9.00%
Australia 9.00%
Belgium 4.80%
Belgium 4.80%
Canada 7.70%
Canada 7.70%
Denmark 6.20%
Denmark 6.20%
France 6.30%
France 6.30%
Germany 8.80%
Germany 8.80%
Ireland 7.00%
Ireland 7.00%
Italy 6.80%
Italy 6.80%
Japan 9.30%
Japan 9.30%
Netherlands 7.70%
Netherlands 7.70%
South Africa 9.10%
South Africa 9.10%
Spain 5.80%
Spain 5.80%
Sweden 9.90%
Sweden 9.90%
Switzerland 6.90%
Switzerland 6.90%
United States 8.70%


Solution
a) Data in ascending order b) Data in ascending order

Sr No Country Arithmetic Mean Sr No Country Arithmetic Mean
1 Belgium 4.80% 1 Belgium 4.80%

2 Spain 5.80% 2 Spain 5.80%
3 Denmark 6.20% 3 Denmark 6.20%
4 France 6.30% 4 France 6.30%
5 Italy 6.80% 5 Italy 6.80%
6 Switzerland 6.90% 6 Switzerland 6.90%
7 Ireland 7.00% 7 Ireland 7.00%
8 United Kingdom 7.60% 8 United Kingdom 7.60%
9 Canada 7.70% 9 Canada 7.70%
10 Netherlands 7.70% 10 Netherlands 7.70%
11 United States 8.70% 11 Germany 8.80%
12 Germany 8.80% 12 Australia 9.00%
13 Australia 9.00% 13 South Africa 9.10%
14 South Africa 9.10% 14 Japan 9.30%
15 Japan 9.30% 15 Sweden 9.90%
16 Sweden 9.90%
Median Position = (16+1)/2 = 8.5 Median Position = (15+1)/2 = 8

Median Value = (7.6% + 7.7%) / 2
Median Value = 7.6%
Median Value = 7.65%

Mode
❑ Definition:
➢ The mode is the most frequently occurring value in a distribution
➢ Distributions are unimodal when there is a single most frequently occurring value and
multimodal if there is more than one frequently occurring value
➢ Compute the mode value

Real Equity for the(1900-2000)
Returns given data set Data in ascending order
Country Arithmetic Mean Sr No Country Arithmetic Mean
Australia 9.00%
1 Belgium 4.80%
Belgium 4.80%
2 Spain 5.80% Unimodal
Canada 7.70%
Denmark 6.20% 3 Denmark 6.20%
France 6.30% 4 France 6.30%
Germany 8.80% 5 Italy 6.80%
Ireland 7.00% 6 Switzerland 6.90%
Italy 6.80% 7 Ireland 7.00%
Japan 9.30% 8 United Kingdom 7.60%
Netherlands 7.70% 9 Canada 7.70%
South Africa
Spain
9.10%
5.80%
10 Netherlands Mode = 7.70%
7.70%
Sweden 9.90%
11 United States 8.70% Bimodal
Switzerland 6.90% 12 Germany 8.80%
United Kingdom 7.60% 13 Australia 9.00%
United States 8.70% 14 South Africa 9.10%
15 Japan 9.30%
Source: CFA Institute course material - Level 1 16 Sweden 9.90%

Weighted Mean
❑ Assigning the weights of different frequencies (year-wise/asset-wise/etc) to the

frequencies -> summation of the entire weighted products will provide the weighted
mean
❑ It is a concept applicable to portfolio analysis – generally referred as expected return
Example
❑ For an equally weighted portfolio, compute the portfolio returns over the five years.
❑ The returns for different asset classes are as follows
Solution:
Portfolio
Year Equities Bonds Year We Equities Wb Bonds
Return
2005 -5.0% 7% 2005 50% -5.0% 50% 7.0% 1.00%
2006 12.0% 2% 2006 50% 12.0% 50% 2.0% 7.00%
2007 22.5% -1% 2007 50% 22.5% 50% -1.0% 10.75%
2008 -24.0% 9% 2008 50% -24.0% 50% 9.0% -7.50%
2009 50% 18.5% 50% 6.0% 12.25%
2009 18.5% 6%

Geometric Mean
❑Geometric Mean compounds the previous period return with present

period rate as opposed to Arithmetic Mean
❑For instance, A 2-year fixed deposit of Rs 100 @ 10% will fetch
❑ Arithmetic Mean Return: Rs 120 (100 x 10% x 2)
❑ Geometric Mean Return: Rs 121 (100 x 1.102)
❑Used to compute growth rates of a variable
❑The geometric mean, G of a set of observations X1, X2, …., Xn is
G = √ (1+nX1) (1+ X2)… (1+ Xn) - 1
Year Equities Bonds
where, Xi ≥ 0, i = 1,2,3,…,n 2005 -5.0% 7%
2006 12.0% 2%
Example:
2007 22.5% -1%
❑ Calculate the geometric mean returns and arithmetic mean returns for 2008 -24.0% 9%
equities and bonds over the five years 2009 18.5% 6%

Geometric Mean
Solution
Year Equities Bonds
2005 -5.0% 7%
2006 12.0% 2%
2007 22.5% -1%
2008 -24.0% 9%
2009 18.5% 6%
AM 4.80% 4.60%
GM 3.26% 4.54%

Harmonic Mean
Rahul drove to office at 10

Harmonic mean is obtained by summing the reciprocals of the
km/hour and returned at 14
observations, then averaging that sum by dividing it by the number of
km/hour. What was Rahul’s
observations n and finally taking the reciprocal of the average.
average speed?
Formula:
n
For average speed calculations,
Harmonic Mean is the right
XH = n / i=1∑ (1/X ) i
metric
Where, Xi > 0, I = 1,2,3,…,n
2 HM finds its application in cost To Remember
HM =
1 1 averaging or value averaging ✓AM >= GM >= HM
10 14
= 11.67 km/hour such as SIP investing wherein (if all values are equal: AM = GM = HM else AM >
investments made over an GM > HM)
extended period lowers the total average cost (harmonic mean)

Application of AM, GM and HM
❑ Aisha has invested $4,000 in the debt and $6,000 in the equity market. The debt
investments gave a return of 8.5% and the equity investments gave a return of 11%.
Find the return that she realized from her total investment.
❑ Her sister, Soniya has invested equal capital in two stocks. One stock is priced at $60
and the other is priced at $40. What is the average price she paid per stock?
❑ Find the better fund based on their five year growth rate. Their growth rates per year
is given below:
Year 2010 2011 2012 2013

Fund A 10% 11% -10% 2%
Fund B 12% 12% -15% 4%

Quantiles
Quantile (or fractile) is a value at or below which a stated fraction of

data lies
Major Quantiles are as follows:
• Divides the distribution into four quarters

Quartiles
• There are 4 quartiles
• Divides the distribution into five parts

Quintiles
• There are 5 quintiles
• Divides the distribution into ten parts

Decile
• There are 10 Deciles
Percentile • Divides the distribution into hundred parts

Computation of Quantiles
If we want 25th percentile from a given distribution then

❑ Compute the position of the 25th percentile as
❑ Ly = (n+1) * y / 100
➢ Ly is the location
➢ Py is the percentile
➢ n = number of datapoints
➢ y = position to be found out
❑ L25 = (n+1) * 25 /100
❑ When Ly lies between two closest integer numbers we use linear
interpolation to obtain the value

Quantiles
Example: Real Equity Returns (1900-2000)
❑ For the given data set compute:

Australia 9.00%
➢ 10th and 90th percentile Belgium 4.80%
Canada 7.70%
➢ 1st, 2nd and 3rd quartile Denmark 6.20%
➢ 2nd and 3rd quintile France 6.30%
Germany 8.80%
Ireland 7.00%
Italy 6.80%
Japan 9.30%
Netherlands 7.70%
South Africa 9.10%
Spain 5.80%
Sweden 9.90%
Switzerland 6.90%
United States 8.70%


Quantiles
Solution: In Ascending Order
❑ For the given data set compute: Sr No Country Arithmetic Mean

➢ 10th and 90th percentile
1 Belgium 4.80%
➢ The 15 observations needs to be divided: (15+1) * 10/100 = 2 Spain 5.80%
1.6 3 Denmark 6.20%
4 France 6.30%
➢ Hence, the 10th percentile would be between Rank 1 and 2 5 Italy 6.80%
6 Switzerland 6.90%
➢ Rank 1 is 4.80% and Rank 2 is 5.80% 7 Ireland 7.00%
8 United Kingdom 7.60%
➢ By interpolation the 10th percentile comes to 5.40%: (0.60 9 Canada 7.70%
between 4.80% and 5.80%) 10 Netherlands 7.70%
11 Germany 8.80%
➢ Similarly, 90th percentile will be : (15+1) * 90/100 = 14.4 12 Australia 9.00%
13 South Africa 9.10%
➢ Hence, the 90th percentile would be 9.54% (0.40 between 14 Japan 9.30%
9.30% and 9.90%) 15 Sweden 9.90%

Quantiles

➢ 1st, 2nd and 3rd quartile
1 Belgium 4.80%
2 Spain 5.80%
3 Denmark 6.20%
4 France 6.30%
5 Italy 6.80%
Quartile Calculation Rank Result 6 Switzerland 6.90%
7 Ireland 7.00%
1st (15+1) * 1/4 = 4 Rank 4 6.30% 8 United Kingdom 7.60%
9 Canada 7.70%
2nd (15+1) * 2/4 = 8 Rank 8 7.60% 10 Netherlands 7.70%
11 Germany 8.80%
3rd (15+1) * 3/4 = 12 Rank 12 9.00% 12 Australia 9.00%
14 Japan 9.30%
15 Sweden 9.90%

Quantiles

➢ 2nd and 3rd quintile
1 Belgium 4.80%
➢ The 15 observations needs to be divided: (15+1) * 2/5 = 6.4 2 Spain 5.80%
3 Denmark 6.20%
➢ Hence, the 2nd quintile would be 6.94%: (0.40 between 4 France 6.30%
6.90% and 7.00%) 5 Italy 6.80%
6 Switzerland 6.90%
➢ For the 3rd quintile, (15+1) * 3/5 = 9.6 7 Ireland 7.00%
➢ Hence, the 3rd quintile would be 7.70%: (0.60 between 9 Canada 7.70%
7.70% and 7.70%) 10 Netherlands 7.70%
11 Germany 8.80%
12 Australia 9.00%
14 Japan 9.30%
15 Sweden 9.90%

Quantiles in Investment Practice
▪Quantiles are used in portfolio performance evaluation as well as in investment strategy development and
research
▪Investment analysts use quantiles every day to rank performance—for example, the performance of
portfolios
▪The performance of investment managers is often characterized in terms of the quartile in which they fall
relative to the performance of their peer group of managers
▪For example Dividing data into quantiles based on some characteristic allows analysts to evaluate the impact
of that characteristic on a quantity of interest

Measures of Dispersion
❑ Dispersion is the variability around the central tendency

❑ Mean returns address the returns Sr No Country Arithmetic Mean
❑ Dispersion addresses risk 1 Belgium 4.80%

2 Spain 5.80%
❑ Following are the measures of dispersion 3

4
Denmark
France
6.20%
6.30%
➢ Range 5 Italy 6.80%
6 Switzerland 6.90%
➢ Mean Absolute Deviation 7 Ireland 7.00%
➢ Variance 9 Canada 7.70%
10 Netherlands 7.70%
➢ Standard Deviation 11 Germany 8.80%
Solution: 12 Australia 9.00%
❑ The mean in the adjoining table is 7.60%. A very basic explanation of dispersion would 14 Japan 9.30%
be for instance between Spain and the mean there is a dispersion of 1.80% (difference 15 Sweden 9.90%
between 7.60% and 5.80%)

Range & Mean Absolute Deviation
❑ The range is the difference between the maximum and minimum

values in a data set:
➢ Range = Maximum Value – Minimum Value
❑ Mean Absolute Deviation: Absolute distance from the mean is added
and then divided by the total number of observations
n
∑ Xi - X
MAD = i=1
n
❑ Example:
➢ Calculate the range and MAD for equities and Bond Year Equities Bonds
returns for the past 5 years 2005 -5.0% 7%
2006 12.0% 2%
2007 22.5% -1%
2008 -24.0% 9%
2009 18.5% 6%

Range & Mean Absolute Deviation
Range MAD
Solution
Equities
Year Equities Bonds
Equities Mean = 4.8%
2005 -5.0% 7%
Between -24% and 22.5% i.e. Summation of absolute deviations:
2006 12.0% 2%
46.5%
2007 22.5% -1% |-5 – 4.8| + |12 – 4.8| + |22.5 – 4.8| + |-
2008 -24.0% 9% 24 – 4.8| + |18.5 – 4.8|
2009 18.5% 6%
Bonds = 77.2
Between -1% and 9% i.e. 10% Range 46.5% 10.0% Dividing by total number of observations:
MAD 15.4% 3.3% 77.2 / 5
= 15.44%

Variance and Standard Deviation
A dietician wants to study the calorie

intake pattern of this country. She finds ❑ Variance is the average of squared deviations from the mean
out various calorie intake levels of a ➢ Population Variance n
certain demography. She also finds out ∑ (Xi - µ )2
the average calorie intake. 2 = i=1
σ
Now if she plots this information on a
N
line graph, she can view the dispersion
❑ Standard Deviation is the square root of variance
of various calorie levels.
➢ Population Standard Deviation
She now calculates the standard
√
deviation: - this number will tell her that
n To Remember
on an average the calorie intake of
∑ (Xi - µ )2
σ = i=1 ✓Standard deviation
various individuals varies by what unit. N
is commonly used
I would say standard deviation is a mean
of deviations from mean! measure of risk.

Example
Compute the variance and standard deviation for the following set of observations
Australia 9.00%
Belgium 4.80%
Canada 7.70%
Denmark 6.20%
France 6.30%
Germany 8.80%
Ireland 7.00%
Italy 6.80%
Japan 9.30%
Netherlands 7.70%
South Africa 9.10%
Spain 5.80%
Sweden 9.90%
Switzerland 6.90%
United States 8.70%



Solution
Australia 9.00%
Belgium 4.80%
Canada 7.70%
Denmark 6.20%
France 6.30%
Germany 8.80%
Ireland 7.00%
Italy 6.80%
Japan 9.30%
Netherlands 7.70%
South Africa 9.10%
Spain 5.80%
Sweden 9.90%
Switzerland 6.90%
United States 8.70%
2
Variance 0.02%
Standard Deviation 1.44%

Sample Variance and Sample Standard Deviation
❑ Variance is the average of squared

deviations from the mean Since sampling is done for
estimating the characteristics of
➢ Sample Variance To Remember
the entire population, it is
n essential that the sample data is
✓n- 1 improves the statistical
2 ∑ (Xi - X ) 2
unbiased.
s = i=1 properties of the sample
n-1 variance Using N for calculating sample
❑ Standard Deviation is the square root of ✓It is the number of degrees of variance may result in a variance
variance lower than the actual population
freedom in estimating the
➢ Sample Standard Deviation variance (if the sample selection
population variance was not right). Hence, N-1 is used
√
n for sample variance, which will
✓Once we have the sample mean,
∑ 2 provide a lower value of
(Xi - X ) there are n – 1 independent
s = i=1 denominator and higher value of
n-1 deviations from it. variance, leading to an unbiased
estimation!

Semivariance, Semideviation, and Related Concepts
Semivariance is defined as the average squared deviation below the mean

Semideviation (sometimes called semistandard deviation) is the positive square root of semivariance
To compute the sample semivariance, for example, we take the following steps:
I. Calculate the sample mean
II. Identify the observations that are smaller than or equal to the mean (discarding observations greater
than the mean).
III. Compute the sum of the squared negative deviations from the mean (using the observations that are
smaller than or equal to the mean).
IV. Divide the sum of the squared negative deviations from Step iii by the total sample size minus 1: n − 1.

Semivariance, Semideviation, and Related Concepts
Target semivariance:The average squared deviation below a target value

Target semideviation is its positive square root
▪For asymmetric distributions, variance and semivariance rank prospects’ risk differently
▪variance (or standard deviation) is much more frequently used in investment practice.

Chebyshev’s Inequality
❑ Standard deviation/variance concepts can be extended to compute and analyze the risk-reward
proportions. Some of the extensions are Chebyshev’s inequality and coefficient of variation.
❑ Chebyshev’s inequality:
❑ The proportion of values within k standard deviations of the arithmetic mean is at least 1 – 1/k2 ,
For all k > 1
❑ Predict the minimum number of values that will lie within 3 standard deviations of the mean from
a total of 900 values
❑ Proportions from Chebyshev’s Inequlity
Interval around
k Proportions
the sample mean
1.25 X ± 1.25s 36%
1.5 X ± 1.5s 56%
2 X ± 2s 75%
3 X ± 3s 89%
4 X ± 4s 94%

Coefficient of Variation
❑ Risk and Return cannot be seen in isolation, hence risk-adjusted returns are calculated
and analyzed for a proper reasoning. Few tools are Coefficient of Variation/ Sharpe Ratio
❑ Coefficient of Variation is the ratio of standard deviation of a set of observations to their
mean value
➢ CV = s / X
❑ Inverse of CV explains the returns per unit of risk
❑ Example
➢ Compute the coefficient of variation
➢ Rank the asset classes from most risky to least risky based on coefficient of variation
To Remember
Asset Class Arithmetic Mean Standard Deviation
Equities Small Cap 19% 40% ✓Lower the value of CV, lower is
Equities Large Cap 13% 20% the risk exhibited by the asset
Equities Mid Cap 16% 30%
class

Coefficient of Variation
❑ Solution
CV Rank
Asset Class Arithmetic Mean Standard Deviation
=40/19 = 2.105 1
Equities Small Cap 19% 40%
Equities Large Cap 13% 20% =20/13 = 1.538 3
Equities Mid Cap 16% 30% =30/16 = 1.875 2
❑ Ranking of the asset class in terms of riskiness is done based on highest CV to lowest CV
(higher the CV means more risk per unit of return)

Sharpe Ratio
❑ It is measure of portfolio performance given by the ratio of excess return to

standard deviation
Formula
Sh = (Rp – RFR) / sp
❑ Where,
➢ Sh= Sharpe Ratio
➢ Rp= Portfolio returns
➢ sp= Standard deviation of portfolio returns
To Remember
➢ RFR = risk free rate
✓Risk averse investors
prefer portfolios with a
higher Sharpe Ratio

Sharpe Ratio…
Example
❑ Compute the CV and Sharpe ratio values for equities based on data provided for
the previous 5 years.
❑ Consider the risk free rate of 2%
Year Equities
2005 -5.0%
2006 12.0%
2007 22.5%
2008 -24.0%
2009 18.5%

Sharpe Ratio…
Solution
❑ Risk free rate of 2%
Year Equities
2005 -5.0%
2006 12.0%
2007 22.5%
2008 -24.0%
2009 18.5%
Sharpe Ratio
= 4.80% - 2.00%
Mean 4.8% =0.1456
Std Dev 19% 0.19
CV 4.01
Sharpe Ratio 0.15

Skewness
It is the name given to statistical measure of skew

❑ Normal Curve To Remember
✓ Normal Curve
✓ Symmetric about the mean, mode and median
✓ Negatively Skewed Curve

❑ Skewed Distribution ✓ Skewed part is to left
If someone pulled ✓ Most cases to right
the string of the
✓ There is more count in the tail than expected in
normal distribution
from right! the normal curve (negative skewness)
✓ Negatively Skewed Curve

If someone pulled
✓ Skewed part is to right
the string of the
normal distribution ✓ Most cases to left
from left! ✓ There is more count in the tail than expected in
the normal curve (positive skewness)

Skewness…
Formula:
❑ s = sample standard deviation

❑ n = number of observations
❑ Positive Skew: Mean>Median>Mode

❑ Negative Skew: Mean<Median<Mode

Mean, Median, Mode and Skew
Describe the relative locations of the mean, median, and mode for a
uni-modal, non-symmetrical distribution
❑ Remember that mean is pulled towards the tail whereas the mode
occurs at the peak.
Mo Md M

Kurtosis
❑ It is a statistical measure that tells us when a distribution is more or less peaked

than a normal distribution
To Remember
✓Leptokurtic distribution has taller

peak than the normal distribution
✓Leptokurtic distribution has fatter

tails than a normal distribution.
❑ For all normal distribution kurtosis = 3

➢ Excess kurtosis is kurtosis value greater than normal distribution
➢ Leptokurtic – excess kurtosis positive (+) i.e. more than 3
➢ Platykurtic – excess kurtosis negative (-) i.e. less than 3

Kurtosis…
Formula
❑ Sample Excess Kurtosis
❑ s = sample standard deviation

❑ n = number of observations

AM and GM wrt Investment Returns
Compare the use of arithmetic and geometric means when analyzing

investment returns
❑ Geometric Mean is the appropriate measure for past performance
since returns are compounded every year.
❑ Arithmetic Mean is the best estimator for next year’s return.

Practice Question
1.Published ratings on stocks ranging from 1 (strong sell) to 5 (strong buy) are examples of which
measurement scale?
A)Ordinal
B)Interval
C)Nominal
2.Two portfolios have unimodal return distributions. Portfolio 1 has a skewness of 0.77, and Portfolio 2 has
a skewness of –1.11.
Which of the following is correct?
A)For Portfolio 1, the median is less than the mean.
B)For Portfolio 1, the mode is greater than the mean.
C)For Portfolio 2, the mean is greater than the median

Practice Question
3. In descriptive statistics, an example of a parameter is the:

A)median of a population.
B)mean of a sample of observations.
C)standard deviation of a sample of observations
4. Which of the following groups best illustrates a sample?
A)The set of all estimates for Exxon Mobil’s FY2015 EPS
B)The FTSE Eurotop 100 as a representation of the European stock market
C)UK shares traded on 13 August 2015 that also closed above £120/share on the London Stock Exchange

Solution
1. A is correct. Ordinal scales sort data into categories that are ordered with respect to some characteristic
and may involve numbers to identify categories but do not assure that the differences between scale
values are equal. The buy rating scale indicates that a stock ranked 5 is expected to perform better than a
stock ranked 4, but it tells us nothing about the performance difference between stocks ranked 4 and 5
compared with the performance difference between stocks ranked 1 and 2, and so on
2.A is correct. Portfolio 1 is positively skewed, so the mean is greater than the median, which is greater
than the mode
3.A is correct. Any descriptive measure of a population characteristic is referred to as a parameter
4. B is correct. The FTSE Eurotop 100 represents a sample of all European stocks. It is a subset of the
population of all European stocks.

3 - Statistical Concepts - Market Returns

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Statistical Concepts And Market Returns

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• Summarize large data sets into useful information.

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Population – All members of a specified sample

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• Categorize but not rank data

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Credit Ratings for

Cash Dividends per

Bond maturity • Ratio Scale

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Frequency distribution – tabular display of data summarized into

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Relative frequency – Is the absolute frequency of each interval divided by the

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Compute the frequency distribution for the given set of data

Country Arithmetic Mean

Source: CFA Institute course material - Level 1

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Data in ascending order

Country Arithmetic Mean

Belgium 4.80% Range = 9% - 4.8% = 4.20%

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Cumulative Frequency Polygon Frequency Polygon

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Central Tendency provides a Arithmetic Mean,

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✓Arithmetic mean is affected by large values – for instance the

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Compute the arithmetic mean for the given set of data

Country Arithmetic Mean

Source: CFA Institute course material - Level 1

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▪It is cenre of an object

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Compute the Median Value for the given set of data

Source: CFA Institute course material - Level 1

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a) Data in ascending order b) Data in ascending order

1 Belgium 4.80% 1 Belgium 4.80%

Median Position = (16+1)/2 = 8.5 Median Position = (15+1)/2 = 8

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➢ Compute the mode value

Country Arithmetic Mean Sr No Country Arithmetic Mean

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❑ Assigning the weights of different frequencies (year-wise/asset-wise/etc) to the

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❑Geometric Mean compounds the previous period return with present

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Year Equities Bonds

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Rahul drove to office at 10

extended period lowers the total average cost (harmonic mean)

Year 2010 2011 2012 2013

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Quantile (or fractile) is a value at or below which a stated fraction of

• Divides the distribution into four quarters

• Divides the distribution into five parts

• Divides the distribution into ten parts

Percentile • Divides the distribution into hundred parts