Tracking error: ex-ante versus ex-post measures

Abstract

In this paper we show that ex-ante and ex-post tracking errors must necessarily differ, since portfolio weights are ex-post stochastic in nature. In particular, ex-post tracking error is always larger than ex-ante tracking error. Our results imply that fund managers always have a higher ex-post tracking error than their planned tracking error, and thus unless our results are considered, any performance fee based on ex-post tracking error is unfavourable to fund managers