Economics Risk And Return Questions Medium
The Sharpe ratio is a measure used in finance to assess the risk-adjusted return of an investment or portfolio. It was developed by Nobel laureate William F. Sharpe. The ratio is calculated by subtracting the risk-free rate of return from the expected return of the investment or portfolio, and then dividing the result by the standard deviation of the investment or portfolio's returns.
Mathematically, the Sharpe ratio can be expressed as:
Sharpe Ratio = (Expected Return - Risk-Free Rate) / Standard Deviation
The Sharpe ratio provides investors with a way to evaluate the excess return they are receiving for the level of risk they are taking. A higher Sharpe ratio indicates a better risk-adjusted return, as it implies that the investment or portfolio is generating more return per unit of risk.
Investors can use the Sharpe ratio to compare different investments or portfolios and determine which one offers a better risk-return tradeoff. However, it is important to note that the Sharpe ratio is just one tool among many in investment analysis, and it should be used in conjunction with other metrics and considerations when making investment decisions.