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Risk Metric
Sharpe Ratio
Sharpe Ratio (Risk-Adjusted Return)
Definition
A measure of risk-adjusted performance calculated by subtracting the risk-free rate from the portfolio return, then dividing by the standard deviation. Higher values indicate better risk-adjusted returns.
Formula
(Portfolio Return - Risk-Free Rate) / Portfolio Volatility
Good
> 1.0
Bad
< 0.5
Example
A portfolio with 10% return, 2% risk-free rate, and 12% volatility has a Sharpe of (10% - 2%) / 12% = 0.67. A Sharpe above 1.0 is considered good, above 2.0 is excellent.