8. The Sharpe Measure of Risk-Adjusted Performance
i. calculate and interpret the coefficient of variation and the Sharpe ratio;
What is the Sharpe measure of risk-adjusted performance?
It is a return risk measure that is more precise than standard deviation which measures the reward to total volatility trade-off.
What is the mathematical formula for the Sharpe Measure?
$$\frac{r_p - r_f}{\sigma_p}$$
- r_p
= the mean return to a portfolio
- r_f
= the mean return to a risk-free asset
- (r_p - r_f)
= the extra reward for the added risk taken, called the excess return
- \sigma_p
= the standard deviation of the portfolio returns
What is another term for the Sharpe Measure?
It is also called the reward-to-variability ratio
Do investors prefer to see a larger Sharpe Ratio or a smaller one? Why?
Portfolios with large Sharpe ratios are preferred to those with smaller ratios because we assume that investors prefer return and dislike risk.
Source:
- CFA