CFA Level 1 Quant Methods
Excellent. Let’s now cover Reading 3: Statistical Measures of Asset Returns, which is foundational for
understanding risk, return, and distribution characteristics. Each LOS is detailed with definitions,
formulas, examples, and CFA-style clarity.
📘 READING 3: Statistical Measures of Asset Returns
LOS 3.a: Calculate, interpret, and evaluate measures of central tendency and
location to address an investment problem.
📌 Key Measures:
Measure Formula / Notes Use Case
Arithmetic Mean ˉ=
X ∑ Xi
Expected return in 1 period
n
1/n
Geometric Mean G = (∏ni=1 (1 + Ri )) −1 Compound multi-period return
Median Middle value when data sorted Robust to outliers
Mode Most frequent value For categorical/discrete data
Weighted Mean ˉ w = ∑ w i Xi
X
Portfolio returns
🧠 Interpretation Tips:
Use geometric mean for long-term investment growth.
Arithmetic mean overstates returns if there's volatility.
Trimmed mean / Winsorized mean reduce outlier effect.
✅ EXAM Focus: Know when to use geometric vs arithmetic mean in return series questions.
LOS 3.b: Calculate, interpret, and evaluate measures of dispersion to address an
investment problem.
🔁 Key Measures:
Measure Formula or Concept
Range Max – Min
∑(Xi −μ)2
Variance (population) σ2 = N
ˉ )2
∑(Xi −X
Variance (sample) s2 =
n−1
Standard Deviation Square root of variance
Mean Absolute Deviation (MAD) (\frac{\sum
Coefficient of Variation (CV) CV = σ
ˉ
X
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📊 Interpretation:
Higher variance = higher risk
CV is useful for comparing risk-adjusted performance.
⚠️ Watch out: Using population formula for a sample (and vice versa) is a common trap.
LOS 3.c: Interpret and evaluate measures of skewness and kurtosis to address an
investment problem.
📈 Distribution Shape Insights:
Term Meaning
Skewness Measure of asymmetry
- Positive Long right tail, more small losses, few big gains
- Negative Long left tail, more small gains, few big losses
Kurtosis "Fatness" of tails vs normal distribution
- Leptokurtic (>3) Fat tails, higher risk of extreme outcomes
- Platykurtic (<3) Thin tails, lower probability of extremes
- Mesokurtic (=3) Normal distribution shape
✅ Key CFA Point:
Excess kurtosis = Kurtosis – 3
Normal distribution has:
Skewness = 0
Kurtosis = 3 (Excess = 0)
🔍 Common Exam Setup: Identify distribution type based on skew/kurtosis and determine
investment risk exposure.
LOS 3.d: Interpret correlation between two variables to address an investment
problem.
🔗 Correlation Coefficient (r):
Cov(X, Y )
r=
σX ⋅ σY
Value of r Interpretation
+1 Perfect positive correlation
0 No linear relationship
–1 Perfect negative correlation
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❗ Key Notes:
Measures linear relationship only.
Does not imply causation.
Covariance is scale-dependent; correlation is standardized.
Example:
If asset A and B move in opposite directions consistently, r ≈ −1.
✅ READING 3 TAKEAWAYS:
LOS Key Idea Core Formula / Insight
3.a Central tendency & location Arithmetic vs geometric mean
3.b Dispersion measures Variance, SD, CV
3.c Distribution shape (skew, kurtosis) Skew = 0, Kurtosis = 3 = normal
Cov(X,Y )
3.d Linear relationship between variables r= σX ⋅σY
Would you like me to continue next with Reading 4: Probability Trees and Conditional Expectations
(LOS 4.a–4.c)?
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