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APPENDIX 20 B FAMA’S MEASURE OF NET SELECTIVITY

APPENDIX 20 B FAMA’S MEASURE OF NET SELECTIVITY. FAMA’S MEASURE OF NET SELECTIVITY JENSEN MEASURE : R p - [ R f +  p ( R M - R f )] FAMA MEASURE : R p - R f +  p ( R M - R f )  M 1. RISK-FREE RETURN : R f

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APPENDIX 20 B FAMA’S MEASURE OF NET SELECTIVITY

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  1. APPENDIX 20 B FAMA’S MEASURE OF NET SELECTIVITY

  2. FAMA’S MEASURE OF NET SELECTIVITY JENSEN MEASURE : Rp - [Rf + p (RM - Rf)] FAMA MEASURE : Rp - Rf + p (RM - Rf)M 1. RISK-FREE RETURN : Rf 2. IMPACT OF SYSTEMATIC RISK : p (RM - Rf) 3. IMPACT OF IMPERFECT p -p (RM - Rf) DIVERISIFICATION : M 4. NET SUPERIOR RETURNS Rp - (Rf + p (RM - Rf) DUE TO SELECTIVITY : M 1 + 2 + 3 + 4 = Rp IF A PORTFOLIO IS PERFECTLY DIVERSIFIED ITS p p =M

  3. ILLUSTRATION Rp = 18% RM = 15%p = 28% M = 20%Rf = 9% p = 9% DECOMPOSE THE PORTFOLIO RETURN INTO FOUR COMPONENTS: 1. RISK-FREE RETURN : Rf = 9% 2. IMPACT OF SYSTEMATIC RETURN : p (RM - Rf) = 1.2 (15 - 9) = 7.2% 3. IMPACT OF IMPERFECT DIVERSIFICATION:p -p (RM - Rf) 28 - 1.2 (15 - 9) M 20 = 1.2% 4. NET SUPERIOR RETURNS DUE TO SELECTIVITY:Rp - Rf + p (RM - Rf) = 18 - 9 +28 (15 - 9) = 0.6%M 20

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