Knowledge Coefficient (IC): Definition, Example, and Components

What Is the Knowledge Coefficient (IC)?

The information coefficient (IC) is a measure used to pass judgement on the facility of an investment analyst or an full of life portfolio manager. The information coefficient displays how moderately the analyst’s financial forecasts have compatibility actual financial results. The IC can range from 1.0 to -1.0, with -1 indicating the analyst’s forecasts undergo no relation to the actual results, and 1 indicating that the analyst’s forecasts utterly matched actual results.

The Components for the IC Is


$\begin{array}{cc}& \text{IC}=(2\times \text{Proportion Proper})-1\\ & \text{where:}\\ & \text{Proportion Proper}=\text{Proportion of predictions made}\\ & \text{correctly by the use of the analyst}\end{array}$

get started{aligned} &text{IC} = (2 circumstances text{Proportion Proper}) – 1 &textbf{where:} &text{Proportion Proper} = text{Proportion of predictions made} &text{correctly by the use of the analyst} end{aligned} ​IC=(2×Proportion Proper)−1where:Proportion Proper=Proportion of predictions madecorrectly by the use of the analyst​

Explaining the Knowledge Coefficient

The information coefficient describes the correlation between predicted and actual stock returns, from time to time used to measure the contribution of a financial analyst. An IC of +1.0 indicates an excellent linear relationship between predicted and actual returns, while an IC of 0.0 indicates no linear relationship. An IC of -1.0 implies that the analyst always fails at making a correct prediction.

A knowledge coefficient (IC) rating as regards to +1.0 implies that the analyst has great skill in forecasting. Then again, actually, if the definition of “correct” is that the analyst’s prediction matched the path (up or down) of actual results, then the chances of getting the forecast right kind are 50/50. So even an analyst and not using a skill in anyway could be expected to have an IC of spherical 0, which means that that a part of the forecasts were right kind and section were incorrect. A rating with regards to 0 reveals that the analyst’s forecasting skills are not any upper than results that may be achieved by accident, suggesting that ICs drawing close to -1 are unusual.

The IC is not to be perplexed with the Knowledge Ratio (IR). The IR is a measure of an investment manager’s skill, comparing a manager’s further returns to the volume of chance taken.

The IC and the IR are every portions of the Elementary Legislation of Full of life Regulate, which states {{that a}} manager’s potency (IR) depends upon skill level (IC) and its breadth, or how incessantly it is used.

Example of the Knowledge Coefficient

As a hypothetical example, if an investment analyst made two predictions and got two right kind, the tips coefficient will also be:


$\begin{array}{cc}& \text{IC}=(2\times 1.0)-1=+1.0\end{array}$

get started{aligned} &text{IC} = (2 circumstances 1.0) – 1 = +1.0 end{aligned} ​IC=(2×1.0)−1=+1.0​

If an analyst’s predictions were simplest a part of the time right kind, then:


$\begin{array}{cc}& \text{IC}=(2\times 0.5)-1=0.0\end{array}$

get started{aligned} &text{IC} = (2 circumstances 0.5) – 1 = 0.0 end{aligned} ​IC=(2×0.5)−1=0.0​

If, alternatively. now not some of the predictions were right kind, then:


$\begin{array}{cc}& \text{IC}=(2\times 0.0)-1=-1.0\end{array}$

get started{aligned} &text{IC} = (2 circumstances 0.0) – 1 = -1.0 end{aligned} ​IC=(2×0.0)−1=−1.0​

Hindrances of the Knowledge Coefficient

The IC is simplest vital for an analyst who makes numerous predictions. It is because if there only a small choice of predictions, random chance would perhaps explain moderately numerous the effects. So if there are simplest two predictions made and every are right kind the tips coefficient is +1.0. If, alternatively, the IC is till at or with regards to +1.0 after a variety of dozen predictions have been made, then it is far more as a result of skill than to chance.