Sharpe Ratio

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DEFINITION of 'Sharpe Ratio'

A ratio developed by Nobel laureate William F. Sharpe to measure risk-adjusted performance. The Sharpe ratio is calculated by subtracting the risk-free rate - such as that of the 10-year U.S. Treasury bond - from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns. The ex-ante Sharpe ratio formula is:
 

 

Sharpe Ratio

The ex-post Sharpe ratio uses the same formula but with realized portfolio return instead of expected return.

 

INVESTOPEDIA EXPLAINS 'Sharpe Ratio'

The Sharpe ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. Although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been. A negative Sharpe ratio indicates that a risk-less asset would perform better than the security being analyzed.

A variation of the Sharpe ratio is the Sortino ratio, which removes the effects of upward price movements on standard deviation to measure only return against downward price volatility.

For more on the Sharpe Ratio read Understanding The Sharpe Ratio Better and Finding The Highest Returns With The Sharpe Ratio

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