Return smoothing

What it means

Understated volatility caused by infrequent or appraisal-based valuations rather than by genuinely stable prices.

The exam angle

Inflates Sharpe ratios and depresses measured correlation with public markets. Unsmoothing the series usually removes most of the apparent diversification benefit.

Where it appears in the syllabus

• Risk & Investment ManagementFRM Part II · exam weight 15% · Factor theory, risk budgeting, attribution, hedge funds, illiquid assets.
• Liquidity & Treasury RiskFRM Part II · exam weight 15% · Funding vs market liquidity, LVaR, transfer pricing, IRRBB, LCR and NSFR.
• Alternative InvestmentsCFA Level I · exam weight 6–9% · Private capital, real estate, natural resources, hedge funds, digital assets.

Related terms

• Liquidity-adjusted VaRVaR extended to include the cost of closing the position — the bid–ask spread and the market impact of exiting at size.
• Arbitrage pricing theoryA model deriving expected returns from exposures to multiple systematic factors, assuming no arbitrage rather than a…
• Factor investingBuilding portfolios around systematic return drivers — value, size, momentum, quality, low volatility — rather than…
• Hedge fund replicationReproducing hedge fund returns using liquid instruments and factor exposures, rather than by paying for the funds…
• Marginal VaRThe change in portfolio VaR from a small increase in one position — the position’s contribution to total risk at the…
• Multifactor modelA model explaining returns by exposure to several systematic factors rather than to the market alone.