| The Sharpe Ratio | ||
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The Sharpe Ratio is commonly used as a method for calculating the performance of an investment after adjusting for its risk. This allows investments with different risk possibilities to be directly compared with each other. Definition: Sharpe ratio is the measure of risk-adjusted return of a financial portfolio. ... Description: Sharpe ratio is a measure of excess portfolio return over the risk-free rate relative to its standard deviation. Normally, the 90-day Treasury bill rate is taken as the proxy for risk-free rate. from https://economictimes.indiatimes.com/definition/sharpe-ratio The Sharpe ratio is a ratio of return versus risk. The formula is: Rp = the expected return on the investor's portfolio For example, let's assume that you expect your stock portfolio to return 12% next year. If returns on risk-free Treasury notes are, say, 5%, and your portfolio carries a 0.06 standard deviation, then from the formula above we can calculate that the Sharpe ratio for your portfolio is: (0.12 - 0.05)/0.06 = 1.17 This means that for every point of return, you are shouldering 1.17 "units" of risk. Put another way, if portfolio X generates a 10% return with a 1.25 Sharpe ratio and portfolio Y also generates a 10% return with a 1.00 Sharpe ratio, then X is the better portfolio because it achieves the same return with less risk. from https://investinganswers.com/financial-dictionary/ratio-analysis/sharpe-ratio-4947 Like many other ratios Sharpe rests on a number of assumptions. Perhaps the major disadvantage is that the Sharpe ratio assumes that investment returns conform to a normal distribution pattern. This is clearly not neces sarily the case, and consequently must be born in mind when perusing the findings. Basic Sharpe ratio Calculation E.G. Mutual Fund Returns By way of introduction let's take a look at a basic Sharpe calculation. First we need 4 columns (see interactive google spreadsheet below). The first column is the Period of the investment returns (this can be months, years etc). Then we have period return amounts. Next we have the risk free return. This is the return you would get if you inveted in a no risk asset (often the Government Bond Yield is used here). Finally the excess return, this is the actual return minus the risk free return. Zoho Interactive Spreadsheet
What does this Sharpe Ratio of 0.899068 mean? Remember the Sharpe Ratio gives us a figure with which to compare investments that, by definition, vary in both risk and return. Now it isn't the easiest thing in the world to find a definitive definition of a good Sharpe Ratio. Following a number of analyses we wil use R analysis and Yahoo finance to consider some examples of real data Sharpe analysis. Examples & sources - Investopedia:Understanding the Sharpe Ratio. To give you some insight, a ratio of 1 or better is considered good, 2 and better is very good, 3 and better is considered excellent. Yahoo Finance:Why you should use the Sharpe ratio when investing in the medical device industry A Sharpe ratio of 1 is considered good, while 2 is considered great and 3 is considered exceptional. Morningstar classroom: How to use the Sharpe ratio Of course the higher the Sharpe ratio the better. But given no other information you can't tell whether a Sharpe ratio of 1.5 is good or bad. Only when you compare one fund's Sharpe ration with that of another fund (or group of funds) do you get a feel for its risk adjuted return relative to other funds. And what of a negative Sharpe ratio? Sharpe Ratio is return minus risk divided by standard deviation (volatility). Now standard deviation (volatility) can't be negative. That means that if the Sharpe Ratio is negative then the excess return is negative.
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