We are all aware of the Sharpe Ratio – the ratio between excess return and risk. Mathematically, it is (average return - benchmark return)/standard deviation of excess returns. The main drawback of the Sharpe Ratio is that market returns have fat tails, skews and kurtosis. Numerous performance ratios have been proposed to take care of these “higher moments.” One of them is the Omega Ratio.
The math is a bit hairy. I encourage inquisitive readers to go through Quantdare’s post on this topic. It also has a link to the original paper.
However, using R to calculate Omega is straightforward enough. Here is how a plot of rolling 5-year Omega of the S&P 500 and NIFTY 50 Dollar indices looks like:
Is it really a step up from the original Sharpe Ratio?
Code and charts are on github.
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