Risk glossary

Sharpe ratio

The Sharpe ratio is a risk-adjusted measure of performance developed by Nobel laurate William Sharpe in 1966. It is calculated as the ratio between the excess return (return in excess of the risk-free rate) and the volatility of a given portfolio. While widely used to show funds’ performance, the Sharpe ratio may be misleading in the case of non-normal distribution of returns, which in finance is most often the case. It has also been criticised for equally weighting positive and negative price movements that contribute to volatility, as it implicitly indicates that positive shocks augment the portfolio’s riskiness. The Sortino ratio overcomes this by calculating the volatility formed by negative returns only.