M2 Measure.The M2 measure also known, as the as the Modigliani risk-adjusted, performance measure is a risk - adjusted performance. Measure. It is closely related to the Sharpe ratio but does, not have the downside of bring "dimensionless" measure moreover,,, In case of negative return the M2, measure continues to hold its meaning while the Sharpe ratio very hard to interpret.M2 Measure CALCULATION.The main question we want to address first is; how to measure M2? Practically calculating the, M2 measure is not more difficult. Than measuring the Sharpe.Step 1.First, of all we need to calculate the Sharpe ratio. In a, next step we will use the Sharpe ratio to derive the M2, measure. Thus first we, perform the following calculate which is just the standard (annual) Sharpe ratio the Sharpe ratio equation.Step 2.The second step consists of multiplying the Sharpe ratio by the (annualized) standard deviation of a benchmark. The benchmark. Can be, freely chosen e.g. The S&P500 index the MSCI, World index or another, broad index.Step 3.In last step we add, the risk free rate again.We can rewrite the above measure differently to get a better understanding of what the M2 measure captures. As shown in. The, equation below the M2 measure equals the excess return weighted over the benchmark "s and portfolio s standard deviation." And increased with the risk free return. Clearly the M2, measure just equals the portfolio "s return when had the standard. Deviation of the portfolio equaled that of the benchmark. This is the case when happens when the portfolio is simply tracking. An index.ALTERNATIVE M2 MEASURE.The is also an alternative M2 measure that is sometimes computed by Practioners. In, this case the systematic risk component. Is used instead of the full volatility component. However this is, only be a good indicator when the portfolio is well, diversified. Under diversification may result in an underestimation of the riskiness of the the, report portfolio as their may be some. Idiosyncratic risk left.Summary.The M2 measure is an alternative and easy to alternative and easy to interpret risk-adjusted performance metric. If s closely. Related to the Sharp ratio from which, if is derived.
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