




The Sharpe Ratio is a simple measure of the riskadjusted return of an asset or portfolio. Using the Sharpe Ratio investors can compare investment strategies or managers, taking into account the amount of risk exposure each has in relation to their returns. The Sharpe Ratio was developed by William Forsyth Sharpe in 1966. (Sharpe was awarded the Nobel Prize in Economics in 1990 for his development of CAPM.) Due to it's simplicity and ease of calculation, the Sharpe Ratio is a tool all investors can use to guage their riskadjusted performance. The Sharpe Ratio also can help investors make decisions about their portfolio allocation.
The Sharpe Ratio is calculated by dividing the difference between the average return for the portfolio and the riskfree rate of return by the standard deviation of returns for the portfolio. The formula for the Sharpe Ratio looks like:
S(x) = (Rx  Rf) / StdDev(x)
Where x = portfolio, Rx = average returns of portfolio, Rf = riskfree rate of return, and StdDev(x) = the standard deviation of returns for x.
The Sharpe Ratio provides some insight into the efficiency of the portfolio by showing the amount of return generated per unit of risk assumed. The higher the Sharpe Ratio the better relationship of reward to risk in the portfolio. Because the Sharpe Ratio takes volatility of a portfolio into account its use is helpful when comparing different investment strategies or managers. The Sharpe Ratio concludes that the strategy or manager exhibiting the highest return with the lowest amount of risk (as measured by standard deviation) would be the better choice.
Rate this Sharpe Ratio definition...




Where is the market headed? The answer may surprise you. Find out with the exclusive & Barron's recommended charts of Chart of the Day. 

Popular Terms: labor relations, balance sheet, VIX, implied volatility, current ratio, reverse mortgage, risk management, minority interest, option premium, inflation, EBITDA, average price per share, exdividend date, annual return, 144a, whollyowned subsidiary, irrevocable trust, Key Rate Duration, APR, stock split, debt service coverage, deferred tax, 1031 exchange, LIBOR, real GDP, Zero Cost Collar, liquidity ratio, 1035 exchange, FTSE, phantom income, covered put, in escrow, stock market close, per diem, margin rate, open position, quality assurance, dividends payable, deferred revenue, required rate of return, FICO score, retained earnings, diluted share, 401a, class C shares, exdividend, command economy, limit order, cancelled check


 