How to Calculate Sharpe Ratio
What is Sharpe Ratio?
The Sharpe ratio measures risk-adjusted return by comparing excess return to volatility. Higher ratios indicate better returns per unit of risk, useful for comparing investments.
Formula
Sharpe ratio = (Portfolio return - Risk-free rate) / Standard deviation
Step-by-Step Guide
- 1Calculate average portfolio return
- 2Subtract risk-free rate (treasury yield)
- 3Divide by portfolio standard deviation (volatility)
Worked Examples
Input
Return: 10%, Risk-free: 2%, Volatility: 15%
Result
Sharpe ≈ 0.53
(0.10 - 0.02) / 0.15
Common Mistakes to Avoid
- ✕Ignoring risk-free rate
- ✕Using realized volatility instead of forward estimates
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