Definition
The Sharpe ratio, developed by William Sharpe (Nobel Prize 1990), divides excess return (above risk-free rate) by standard deviation to measure reward per unit of risk. Higher Sharpe ratios indicate better risk-adjusted performance. A Sharpe above 1.0 is good, above 2.0 is excellent. It is the most widely used risk-adjusted performance metric.
functions Formula
Sharpe Ratio = (Rp − Rf) / σp
lightbulb Example
Portfolio returns 12%, risk-free rate is 4%, portfolio std dev is 16%. Sharpe = (12%-4%)/16% = 0.50. A competing fund returns 10% with 8% vol: Sharpe = (10%-4%)/8% = 0.75—better risk-adjusted performance.
verified_user Key Points
- Most common risk-adjusted performance measure
- Higher is better—more return per unit of risk
- Above 1.0 considered good, above 2.0 excellent
- Uses total volatility (not just systematic risk)