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miƩrcoles, 10 de mayo de 2017

What is the Sharpe ratio?

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The Sharpe Ratio was developed by Nobel Prize William Sharpe of Stanford University. It measure numerically the historical Profitability/Volatility (standard deviation) ratio of an Investment Fund. It is calculated by dividing the yield of a fund minus the risk-free interest rate between the volatility or standard deviation of that return over the same period.

Sharpe Ratio = Fund performance - Risk-free interest rate (3-month bills)/Standard deviation of fund performance (historical volatility)

The higher the Sharpe Ratio, the better the fund's return relative to the amount of risk that has been taken on the investment. The higher the volatility, the greater the risk, since the probability that the fund has negative returns is greater the greater the volatility of its yields. Likewise, the greater the volatility, the greater the likelihood of high positive returns. Therefore, when the volatility of the fund is large, the greater the denominator of the equation and the smaller the Sharpe Ratio.