Sharpe

Definition

The Sharpe Ratio is a measure used to evaluate the risk-adjusted return of an investment portfolio. It is calculated by subtracting the risk-free rate from the portfolio's return and dividing the result by the portfolio's standard deviation.

5 Must Know Facts For Your Next Test

1. The Sharpe Ratio helps investors understand how much excess return they are receiving for the extra volatility they endure for holding a riskier asset.
2. A higher Sharpe Ratio indicates better risk-adjusted performance.
3. It was developed by Nobel Laureate William F. Sharpe in 1966.
4. The formula for the Sharpe Ratio is (Rp - Rf) / σp, where Rp is the return of the portfolio, Rf is the risk-free rate, and σp is the standard deviation of the portfolio's excess return.
5. It assumes that returns are normally distributed and does not account for skewness or kurtosis in return distributions.

Review Questions

• What does a higher Sharpe Ratio indicate about an investment's performance?
• Who developed the Sharpe Ratio and in what year?
• What components are needed to calculate the Sharpe Ratio?

Related terms

Alpha: A measure of an investment's performance on a risk-adjusted basis compared to a benchmark index.

Beta: Indicates an investment's volatility relative to its market or benchmark.

Standard Deviation: A statistical measure of market volatility, measuring how widely prices are dispersed from their average value.