Are you just about to embark on your journey in the investment world? If so, you should consider learning some of its basics such as information coefficient.
You might be wondering what information coefficient is and why you should understand it. It is rational to have a question like this because, if you don’t know what it is and its purpose, why bother?
To begin with, information coefficient is a form of measurement. It, in addition, is highly useful to measure the skill of an investment analyst.
Basically, it evaluates how close an investment analyst’s financial forecast is to the actual financial results. In conducting investment, a forecast is highly influential to the decision-making process.
The basis why you should understand it is due to the needs to rely on such analysts, especially for novice investors. To invest without an analyst might result in undesirable outcomes though analysts cannot utterly warrant the success of an investment.
That being said, blindly choosing investment analysts without knowing their proficiency might also lead to your demise. This is why information coefficient is salient.
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How to Calculate Information Coefficient
Information coefficient ranges from 1.0 to -1.0. Accordingly, 1.0 means that the analyst’s forecasts match the actual results, while -1.0 suggests the opposite.
The formula to calculate it is very simple. You can simply follow this formula.
IC=(2×Proportion Correct)−1
Proportion correct translates to the proportion of correct predictions. Put it simply, if an analyst generates 6 predictions and 3 among them are accurate, then the proportion correct is 0.5 (half of the total predictions).
To make it more understandable, let us move to examples. Situate that an analyst makes 2 predictions.
If both are correct, then it is like this:
IC=(2×1.0)−1 = 2.0 – 1 = 1.0
If only one is correct, then it is like this:
IC=(2×0.5)−1 = 1.0 – 1 = 0.0
If both are incorrect, then it is like this:
IC=(2×0.0)−1 = 0.0 – 1 = -1.0
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