Sharpe Ratio

The Sharpe ratio, named after US economist William F Sharpe, is a measure of risk-adjusted returns. It takes the expected excess return of an investment (i.e. its expected return minus the risk-free return) and divides it by the volatility of the return (as measured by its standard deviation). As such, the higher the Sharpe ratio the better outcome for a risk-sensitive investor. Risk-sensitive investors considering two investment options may opt to forego the investment with a higher expected return if it has a lower Sharpe ratio than the investment with lower expected returns but with a better Sharpe ratio.

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