What is a Sharpe Ratio?

Sharpe Ratio, also known as the Sharpe Index-a standardized indicator of fund performance evaluation. The study of Sharpe ratio in modern investment theory shows that the magnitude of risk has a fundamental role in determining the performance of the portfolio. The risk-adjusted rate of return is a comprehensive indicator that can consider both benefits and risks, in order to eliminate the adverse impact of risk factors on performance evaluation. The Sharpe ratio is one of three classic indicators that can comprehensively consider both benefits and risks. There is a common feature in investment, that is, the higher the expected return of the investment target, the higher the risk of fluctuations that the investor can tolerate; conversely, the lower the expected return, the lower the risk of fluctuation. Therefore, the main purpose of a rational investor choosing an investment target and a portfolio is: to pursue the maximum return under a fixed and acceptable risk; or to pursue the lowest risk under a fixed expected return.

Sharp ratio

Rational investors will choose and hold effective

Where E (Rp):

Questions that Sharp Ratio should pay attention to in application Although Sharp Ratio is very simple in calculation, it is still necessary to pay attention to the applicability of Sharp Ratio in specific applications:

1.Use

The calculation of the Sharpe ratio is very simple.

The theoretical basis for sorting fund performance based on the size of the Sharpe ratio is that it is assumed that investors can borrow at a risk-free interest rate. In this way, by determining the appropriate financing ratio, a fund with a high Sharpe ratio can always obtain a ratio with equal risk. Funds with low Sharpe ratios have high investment returns. For example, suppose there are two funds A and B. The average annual growth rate of fund A is 20% and the standard deviation is 10%. The average annual growth rate of fund B is 15% and the standard deviation is 5%. The risk interest rate is 5%. Then, the Sharpe ratios of Fund A and Fund B are 1.5 and 2, respectively. Based on the Sharpe ratio, the risk-adjusted return of Fund B is better than that of Fund A. In order to explain this more clearly, you can incorporate the same amount of funds (financing ratio 1: 1) at the risk-free rate and invest in B. Then, the standard deviation of B will be doubled to reach A The same level, but at this time B's net worth growth rate is equal to 25% (ie 2 * 15% -5%) is greater than A fund. The use of monthly and annual sharp ratios is more common. ^[1]