Sharpe Ratio

The Sharpe Ratio was invented by William F. Sharpe. The invention of this Nobel laureate has been very helpful in computing the functioning of a particular trading strategy or an asset. These calculations are done only after adjusting for the related risk factors. The Sharpe Ratio is popularly termed as Sharpe Index or reward-to-variability. It is also called as Sharpe Measure. The Sharpe Ratio was modified in 1994 by William F. Sharpe himself.

The risk premium is the surplus return earned through every unit of risk related to the investment or the trading techniques. The computations are done by deducting the rate that is risk free from the return rate of a certain portfolio. After that, the result or the sum is divided by the standard deviation of the returns provided by the particular portfolio.

A portfolio can provide high returns for several reasons. Firstly, it may be the wise investment strategies that an individual follows to achieve the investment objectives. At the same time, there may be some other reasons behind the high income or returns from the investments. There are a number of investors who are always ready to face risks in the market because higher risks can also produce higher returns.

The Sharpe Ratio is very helpful in deciding the fact that if the returns are produced by the investment strategies or due to the amount of risk that is related to the portfolio. This is very useful for the investors because a wide range of investment products is available in the market and many of these can be used to build an investment portfolio. So, the investment portfolios can also vary and the returns from these products are also different. Now, among all these portfolios, only those that are able to produce high returns without inviting too much of risks are preferred. An investor can consult the Sharpe Ratio before making investment because if a portfolio enjoys higher Sharpe Ratio, the performance of that particular portfolio is expected to be very good.

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Last Updated on : 1st July 2013

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