From the textbook, information coefficient (IC) is a measure of the depth of an active manager’s skill. On a more formal basis, IC measures the “correlation” between actual returns and those predicted by the portfolio manager (Grinold & Kahn, 2000; Fabozzi & Markowitz, 2011). Cross-checking Investopedia suggests the same thing. That is, it's the pearson correlation between returns and scores. However, my colleague is adamant that it's the rank correlation not the pearson correlation. Which one is correct?
Depends on your purpose. Rank correlation as information coefficient makes sense for cross-sectional strategies.
Example: You are running a long-short fund. Start by ranking the returns of assets for the next time period then go long on high ranked assets and go short on low ranked assets.