As a financial ratio the Sortino ratio shares a number of similarities with the Sharpe ratio. Actually the Sortino ratio is a modified version of Sharpe ratio. Through this ratio the returns are calculated after doing the necessary adjustments for the related risk factors. Because of this, the Sortino ratio is widely used by the investors, as it seems to be more practical than the Sharpe ratio. The semi-volatility is treated as denominator in the Sortino ratio. There are certain ratios that treat the semi-volatility as standard deviation. At the same time, it is mainly because the semi-volatility is treated as denominator that the Sortino ratio is able to provide calculations regarding returns related to negative volatility.
Formula of Sortino Ratio:
S = (R-T)/DR In this particular formula, ‘R’ represents the returns. On the other hand, ‘T’ denotes the expected return rate. This is regarded as minimum acceptable return. Downside risk is represented by ‘DR’. The downside risk or volatility represents the returns that are less than the MAR.
The difference between the positive and negative volatility is done by downside deviation. In the standard deviation, these differences are very hard to find. Because of this, the standard deviation cannot be a complete measure of risk. At the same time, the Sharpe ratio that uses the standard ratio is also not regarded as a complete ratio.
Last Updated on : 1st July 2013