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Sharpe Ratio

The Sharpe Ratio is a measure of the risk-adjusted return of an investment.

where r is the average monthly return, rr f is the risk-free return (we use 1% per year as a risk-free return) and s is the standard deviation of the monthly returns over the same period.

This gives you s, the monthly Sharpe you can annualize by multiplying it by the square root of 12.

Sharpe ratio is a measure of risk–adjusted performance that indicates the level of excess return per unit of risk. In the calculation of Sharpe ratio, excess return is the return over and above the short–term risk free rate of return and this figure is divided by the risk, which is represented by the annualized volatility or standard deviation. In summary the Sharpe Ratio is equal to compound annual rate of return minus rate of return on a risk–free investment divided by the annualized monthly standard deviation. The greater the Sharpe ratio the greater the risk–adjusted return.

 


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