Before we answer your question, let's first define tracking error and ex-post risk. Tracking error refers to the amount by which the returns of a stock portfolio or a fund differ from those of a certain benchmark. As you might expect, a fund that has a high tracking error is not expected to follow the benchmark closely, and it is generally seen as being risky.

The other component of the question is ex-post risk, which is a measure of the variance of an asset's returns relative to a mean value. In other words, ex-post risk is the statistical variance of an asset's historical returns. Many individuals would argue that tracking error is not the best measure to determine ex-post risk because it looks at the returns of a portfolio relative to a benchmark rather than looking at the variability in the portfolio's returns. Tracking error can be a useful tool when determining how closely a portfolio mimics a stable benchmark, or how efficient a portfolio's manager is at tracking a benchmark, but many would argue that this is not a good measure of how much an investor can expect to gain or lose on any given trading day. However, ex-post risk, unlike tracking error, can provide an estimate of the probability that the expected return of a portfolio will drop by a certain amount on any given day, which is why it is a common risk metric used by professionals when studying things such as value at risk.

Using tracking error as a measure of ex-post risk would only make sense when tracking error is equal to zero because when an investor's portfolio consists of many stable companies that have produced predictable, stable returns, the historical variance of the benchmark's returns would be equal to those of the portfolio.

To learn more see, Introduction To Value At Risk (VAR) - Part 1 and Part 2 and Determining Risk And The Risk Pyramid.


    Understand what tracking error is and learn about the significant difference it can represent for investors who favor index ... Read Answer >>
  2. How is the standard error used in trading?

    Understand how the standard error is used in statistics and what it measures. Learn how the standard error is used in trading ... Read Answer >>
  3. What is a relative standard error?

  4. What are the advantages and disadvantages of zero-based budgeting in accounting?

  5. How do financial markets react to recessions?

    Learn more about the relationship between recessions and financial markets by identifying the fundamental characteristics ... Read Answer >>

    Read about the most important benchmarks that can be used to track the banking sector, and why banking benchmarks tend to ... Read Answer >>
Related Articles
  1. Investing

    What Does Ex-Post Mean?

    In Latin, the term ex-post means “after the fact.” Applied to finance and investing, ex-post refers to the analysis and timing of actual returns.
  2. ETFs & Mutual Funds

    3 Reasons Tracking Error Matters

  3. Investing

    Calculating Tracking Error

    Tracking error is the difference between the return on a portfolio or fund, and the benchmark it is expected to mirror (or track).
  4. Managing Wealth

    Is Your Portfolio Beating Its Benchmark?

    Compare portfolio manager performance using the information ratio.
  5. Managing Wealth

    How to Use a Benchmark to Evaluate a Portfolio

    What is an investment benchmark and how is it used to evaluate the risk and return in a portfolio.
  6. ETFs & Mutual Funds

    ETF Tracking Errors: Protect Your Returns

  7. Trading

    Make Your Portfolio Safer With Risky Investments

  8. ETFs & Mutual Funds

    What's a Benchmark?

  9. Managing Wealth

    How to Select and Build a Benchmark to Measure Portfolio Performance

    How to select and build a benchmark to measure the performance of your investment portfolio
  10. Managing Wealth

    Top 3 Mistakes That Cause Traders To Fail

  1. Ex-Post

    Another term for actual returns. Ex-post translated from Latin ...
  2. Ex-Post Risk

    A type of risk measurement technique that uses historic returns ...
  3. Tracking Error

    A divergence between the price behavior of a position or a portfolio ...
  4. Accounting Error

    An error in an accounting item that was not caused intentionally. ...
  5. Non-Sampling Error

  6. Error Of Principle

Hot Definitions
  1. Diversification

  2. European Union - EU

  3. Sell-Off

  4. Brazil, Russia, India And China - BRIC

  5. Brexit

  6. Underweight

Trading Center