Sharpe Ratios are often used to sort through competing investments. It is the original “risk adjusted returns.” It’s a mathematical expression of the insight that excess returns over a period of time may signify more volatility and risk, rather than investing skill (investopedia, wikipedia).
![](https://portalvhds29z8xdrqhczq.blob.core.windows.net/wordpress/2023/02/image.png)
Rb or Rf, the risk-free return, is usually cumbersome to handle. So, typically, it is either set to zero or a constant value. The problem is that rates vary over time and has an impact on the relative ordering of investments.
![](https://raw.githubusercontent.com/stockviz/blog/master/volatility/sharpe/sharpe-sensitivity-Rf.png)
At high interest rates, SR(mid-caps) > SR(large-caps)
Ideally, you want your Sharpes to be positive and stable. Unfortunately, that is never the case.
![](https://raw.githubusercontent.com/stockviz/blog/master/volatility/sharpe/sharpe-actual-Rf.rolling.png)
During bull markets, Sharpes trend up and reverse course in bears.
![](https://raw.githubusercontent.com/stockviz/blog/master/volatility/sharpe/sharpe-actual-Rf.rolling.density.png)
At the end of the day, it boils down to whether the returns are worth the risk.
![](https://raw.githubusercontent.com/stockviz/blog/master/volatility/sharpe/cumulative.returns.png)
You might very well be trying to catch lightening in a bottle.
![](https://raw.githubusercontent.com/stockviz/blog/master/volatility/sharpe/annual.returns.png)
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