Normal Return Gaps
Posted: 1 Feb 2016 Last revised: 1 Apr 2020
Date Written: January 30, 2016
Despite ever more sophisticated risk management and measurement, investment professionals have generally overlooked a simple but powerful metric of relative risk and portfolio diversification -- the normal return gap. We develop a generalized specification of the expected difference in returns between two investments based on the normal distribution. We then demonstrate its applicability to capital market forecasts, manager selection, performance evaluation, style tilts, manager combinations, and rebalancing.
Keywords: portfolio choice, asset allocation, performance analysis, risk, private wealth management, mathematical methods
JEL Classification: G11, G23, C58, C65
Suggested Citation: Suggested Citation