Question

Consider a hypothetical exercise to evaluate the skill of four financial analysts (Analyst 1, Analyst 2, Analyst 3, and Analyst 4). On December 31 of a given year, each analyst tries to pick a ‘good’ U.S. stock. On December 31 of the subsequent year, the return on this stock is recorded.

Suppose that the returns on the stocks picked by the analysts were as follows:

i. Analyst 1, +14%;

ii. Analyst 2, +15%;

iii. Analyst 3, +16%; and

iv. Analyst 4: +17%.

Do these returns suggest that:

a. The four analysts do not have skill;

b. The four analysts have skill;

c. None of the above?

explain

  

Answer 1

The answer is "C" - None of the above

You can only say that the returns are good or bad when you can compare them with something. All the stocks that they have chosen belong to some sector. You need to check the Index return of that sector. If the returns are more than Index returns, then they have picked good stocks as it has generated alpha. If they have generated return equal to index, then that is market return which you have got by just buying ETF. So to pass a judgement you need something to compare with.