Sharpe Ratio Formula

Sharpe Ratio Formula Explained

Sharpe ratio is excess return divided by risk.

Excess return is the return on the investment (portfolio, fund, trading strategy) less risk-free return (treasury yield, money market rate).

Risk is represented by the standard deviation of returns on the investment.

Therefore, Sharpe ratio equals expected return on the investment less risk-free rate, divided by standard deviation of returns on the investment:

\[{Sharpe\:Ratio}={{\bar{r}_p\:-\:r_f}\over\sigma_p}\]

\(\bar{r}_p\) = expected return of the portfolio or investment
\(r_f\) = risk-free interest rate
\(\sigma_p\) = standard deviation of portfolio returns

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