The Sharpe Ratio measures risk-adjusted return by comparing excess return over a risk-free rate to portfolio volatility. It was developed by Nobel laureate William F. Sharpe in 1966.

Formula

$$Sharpe\ Ratio = \frac{R_p - R_f}{\sigma_p}$$

• $$R_p$$: Expected portfolio return
• $$R_f$$: Risk-free rate (e.g. government treasury bills)
• $$\sigma_p$$: Standard deviation of portfolio returns (volatility)

Interpretation

• > 3.0: Excellent risk-adjusted performance
• 2.0 – 3.0: Very good
• 1.0 – 2.0: Good
• < 1.0: Inadequate compensation for the risk taken