Information Ratio
Active return per unit of tracking error; measures excess performance vs a benchmark in backtesting.
Definition
Information ratio (IR) = (R_strategy − R_benchmark) / TE, where TE is the tracking error (standard deviation of the strategy’s return minus the benchmark return). It measures active return per unit of active risk.
Why it matters for backtesting
- Active management: Standard metric for long-only or benchmark-relative strategies.
- Consistency: High IR implies the strategy consistently beats the benchmark without large deviations.
- Capacity: Strategies with high IR and low tracking error may be more scalable.
Limitations
- Only meaningful when a clear benchmark exists.
- Sensitive to the benchmark; changing benchmark changes IR.
- Does not account for absolute level of return or drawdown.
Linked concepts
Alpha, beta, Sharpe ratio, tracking error.