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Pitfalls in Risk Attribution
Feb 24, 2011
While performance analysis is typically conducted on a benchmark-relative basis, risk analysis is often presented on an absolute-return basis. This mismatch between sources of risk and return leads to the pitfall that active management decisions cannot be evaluated on a risk-adjusted basis. In particular, usage of absolute return sources in risk attribution may lead to non-intuitive marginal contributions to risk and flagging aggressive positions as risk reducing. These pitfalls can be addressed by using relative MCARs, which result in a set of consistent and intuitive effects across securities, sectors, and factors.
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