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Sharpe ratio. In finance, the Sharpe ratio (also known as the Sharpe index, the Sharpe measure, and the reward-to-variability ratio) measures the performance of an investment such as a security or portfolio compared to a risk-free asset, after adjusting for its risk. It is defined as the difference between the returns of the investment and the ...
When a risk-free asset is introduced, the half-line shown in the figure is the new efficient frontier. It is tangent to the hyperbola at the pure risky portfolio with the highest Sharpe ratio. Its vertical intercept represents a portfolio with 100% of holdings in the risk-free asset; the tangency with the hyperbola represents a portfolio with ...
An example capital allocation line. As illustrated by the article, the slope dictates the amount of return that comes with a certain level of risk. Capital allocation line (CAL) is a graph created by investors to measure the risk of risky and risk-free assets. The graph displays the return to be made by taking on a certain level of risk.
The Sharpe ratio is awkward to interpret when it is negative. Further, it is difficult to directly compare the Sharpe ratios of several investments. For example, what does it mean if one investment has a Sharpe ratio of 0.50 and another has a Sharpe ratio of −0.50? How much worse was the second portfolio than the first?
As an example of the different conclusions that can be drawn using these two ratios, notice how the Lehman Aggregate and MSCI EAFE compare - the Lehman ranks higher using the Sharpe ratio whereas EAFE ranks higher using the Sortino ratio. In many cases, manager or index rankings will be different, depending on the risk-adjusted measure used.
The single-index model (SIM) is a simple asset pricing model to measure both the risk and the return of a stock. The model has been developed by William Sharpe in 1963 and is commonly used in the finance industry. Mathematically the SIM is expressed as: where: These equations show that the stock return is influenced by the market (beta), has a ...
The Calmar ratio uses a slightly modified Sterling ratio – average annual rate of return for the last 36 months divided by the maximum drawdown for the last 36 months – and calculates it on a monthly basis, instead of the Sterling ratio's yearly basis. [1] Young believed the Calmar ratio was superior because. The Calmar ratio changes ...
The Sortino ratio measures the risk-adjusted return of an investment asset, portfolio, or strategy. [1] It is a modification of the Sharpe ratio but penalizes only those returns falling below a user-specified target or required rate of return , while the Sharpe ratio penalizes both upside and downside volatility equally.