Sharpe Ratio
This statistic is a reward to variability ratio, which offers a means of locating an optimal risky portfolio. The equation is
The expected return minus the riskfree rate then is the portfolio’s risk premium. When this risk premium is divided by the standard deviation, the result provides a relative gauge for portfolio comparison. Thus, given comparable portfolios, the larger the Sharpe ratio, the better off the investor is. The standard deviation used in the denominator of the Sharpe Ratio, by default, is defined as the standard deviation of the series returns. There is an option to “Use standard deviation of riskadjusted series” for this part of the equation though. If you check the “Use standard deviation of riskadjusted series,” the standard deviation used in the Sharpe Ratio is that of the difference between the series returns and the riskfree series. The default method is the one that we have used in the past for EnCorr software. The method of using the standard deviation of the riskadjusted returns is a method that has become increasingly popular, and is the reason why we give both options. Note: The “Use standard deviation of riskadjusted series” option can only be used if you first select the riskfree rate as a series, not as a Constant Risk Free Rate from the RiskAdjusted Return Measures window. Also see RiskAdjusted Return Measures for information on assigning a riskfree rate for calculation of the Sharpe Ratio.
