Economics Risk And Return Questions Medium
The risk-adjusted return on investment is calculated by taking into account the level of risk associated with an investment and adjusting the return accordingly. There are several methods to calculate risk-adjusted return, but one commonly used measure is the Sharpe ratio.
The Sharpe ratio is calculated by subtracting the risk-free rate of return from the investment's average return, and then dividing the result by the investment's standard deviation. The risk-free rate of return is typically the return on a risk-free asset, such as a government bond.
Mathematically, the formula for the Sharpe ratio is as follows:
Sharpe Ratio = (Average Return - Risk-Free Rate) / Standard Deviation
A higher Sharpe ratio indicates a better risk-adjusted return, as it means the investment is generating higher returns relative to its level of risk. Conversely, a lower Sharpe ratio suggests that the investment is not generating sufficient returns given its level of risk.
It is important to note that the risk-adjusted return is just one measure of evaluating an investment's performance. Other factors such as the investment's liquidity, diversification, and correlation with other assets should also be considered when assessing the overall risk and return profile.