HOMEPAGE

Sharpe Ratio

Definition

The Sharpe Ratio measures the risk‑adjusted return of an investment by comparing excess return to volatility.

$$\text{Sharpe Ratio}=\frac{\text{Portfolio Return}-\text{Risk‑Free Rate}}{\text{Portfolio Standard Deviation}}$$

Why It Matters

• Shows how much return an investor earns per unit of risk.
• Helps compare investments with different volatility levels.
• Core metric in portfolio management and modern finance.
• Higher Sharpe = better risk‑adjusted performance.

How to Interpret It

• Sharpe < 1.0: Suboptimal risk‑adjusted return.
• Sharpe 1.0–2.0: Good.
• Sharpe > 2.0: Excellent.
• Sharpe > 3.0: Exceptional (rare).

Example

A portfolio earns:

• Return: 12%
• Risk‑free rate: 2%
• Standard deviation: 8%

$$\text{Sharpe}=\frac{12-2}{8}=1.25$$

A Sharpe Ratio of 1.25 indicates strong risk‑adjusted performance.