Sharpe ratio measures excess return per unit of risk: (R - Rf) / σ
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Sharpe ratio
Sharpe ratio measures excess return per unit of risk: (R - Rf) / σ
The Sharpe ratio quantifies the excess return of an investment compared to a risk-free asset, adjusted for risk. It is a key metric in finance for evaluating investment performance.
The Sharpe ratio is calculated by taking the difference between the investment's return and the risk-free return, then dividing by the standard deviation of the investment's returns. This formula highlights the trade-off between risk and return.
Developed by William F. Sharpe in 1966, the Sharpe ratio has become a fundamental tool for investors to assess the risk-adjusted performance of their portfolios.
Example
If an investment has a return of 12%, a risk-free rate of 3%, and a standard deviation of 5%, the Sharpe ratio would be (12% - 3%) / 5% = 1.8.
Understanding the Sharpe ratio helps investors make informed decisions by comparing the risk-adjusted returns of different investments.
Related concepts
Treynor ratio
Treynor ratio measures excess return per unit of systematic risk
Deflated Sharpe ratio
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Information ratio
Information ratio = Active return / Tracking error
Cronbach's alpha
Cronbach's alpha (α) measures internal consistency
Beta (finance)
Beta measures a stock's volatility relative to the market
Efficient frontier
Efficient frontier maximizes return for a given risk level
Educational content, not financial advice.
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