Sharpe Ratio
A measure of portfolio efficiency — indicating how much excess return is generated for each unit of total risk taken.
The higher the Sharpe Ratio, the more efficiently the portfolio is converting risk into return. A Sharpe Ratio above 1.0 is generally considered good for an actively managed strategy; above 2.0 is exceptional. The Sharpe Ratio uses total standard deviation (both upside and downside volatility) in the denominator.
Formula: Sharpe Ratio = Portfolio Excess Return / Portfolio Standard Deviation
The Sharpe Ratio is the most widely used risk-adjusted performance metric in institutional investing. However, it treats upside and downside volatility equally — a limitation addressed by the Sortino Ratio, which penalizes only downside deviations.
Frequently Asked Questions
What is the Sharpe ratio?
The Sharpe ratio measures portfolio efficiency — how much excess return is generated per unit of total risk. It equals portfolio excess return divided by standard deviation. Above 1.0 is good; above 2.0 is exceptional.
How is the Sharpe ratio calculated?
Sharpe Ratio = (Portfolio Return - Risk-Free Rate) / Portfolio Standard Deviation. It measures the risk-adjusted return of an investment strategy.
What are the limitations of the Sharpe ratio?
The Sharpe ratio treats upside and downside volatility equally. A strategy with high upside volatility (good for investors) is penalized the same as one with high downside volatility. The Sortino ratio addresses this by only penalizing downside deviations.
Explore with Ora
Ask Ora anything about sharpe ratio and related investment concepts. Get Bloomberg-grade intelligence in plain English, in seconds.