Case study: Sharpe ratio

January 12, 2020

Introduction

It is my personal finance research. I like to learn best business education like Stern business school, or other top business school. What I like to do is to understand the basic concept first, I like to take time to understand Sharpe ratio.

Case study

Here is the article about Sharpe ratio.

I will add my notes here.

The ratio combines standard deviation, the fund's return and the return that could have been earned on a risk-free holding like 90-day Treasury bills guaranteed by the U.S. government.

For example, 25 percent return, standard deviation of 10, at a time T-bills return 5 percent, a Sharpe ratio of 2 ([25-5]/10).

The result 2, is the "risk-adjusted return" the investor could earn for taking on the fund's risk.
Large Sharpe ratio is better. Less risk more return.

Sharpe ratio. Developed by Nobel laureate William F. Sharpe, this measure combines standard deviation, the fund's return and the return that could have been earned on a risk-free holding like 90-day Treasury bills guaranteed by the U.S. government.

In Morningstar's example, a fund with a 25 percent return and standard deviation of 10, at a time T-bills returned 5 percent, would have a Sharpe ratio of 2 ([25-5]/10), Morningstar says. The result, 2, is the "risk-adjusted return" the investor could earn for taking on the fund's risk.

With Sharpe ratio, a bigger number is better. In choosing between two funds with the same average return, you'd be better off with the one offering the larger Sharpe ratio. Sharp ratio is also unusual in that it is useful in comparing funds of very different types.