Investment Performance Evaluation and Prudence: A Unified Approach

The prudence of an investment and its return vs. risk are two concepts that are clearly related. However, formal links between the two are hard to find. By adapting a capability measure from the quality control literature, we present a methodology that links acceptable return to risk prudence for high frequency trading strategies. This new measure is more descriptive than the traditional Sharpe Ratio, Information Ratio, or similar measures, while being robust to skewness, kurtosis, and multiple time horizon decision processes. We also argue that tracing strategies which are capable according to this new multi-scale capability measure must be prudent. The basis of this is that such trades must be both unlikely to seriously injure either the investor or the marketplace, while providing a high likelihood of satisfactory returns.

This is joint work with Ben Van Vliet.