Is the Sharpe Ratio Useful in Asset Allocation?

Macquarie Applied Finance Centre Research Paper

48 Pages Posted: 9 May 2005

See all articles by Steve Christie

Steve Christie

Macquarie University - Department of Applied Finance and Actuarial Studies

Date Written: May 2, 2005

Abstract

Investors often consider Sharpe ratios when making asset allocation decisions and comparing portfolios. Given sampling error in estimated means and variances of returns, promoting Sharpe ratios as useful to help choose between asset allocations or portfolios may be misleading. Estimators of the Sharpe ratio have less helpful distributions than estimators of mean and variance. The error in the estimate of the Sharpe ratio can be simply too large to make useful conclusions. Investors are often overly swayed by historical performance in making investment decisions: why make matters worse by obscuring what information we have by combining past performance characteristics in an unhelpful ratio?

Keywords: Sharpe ratio, estimation error, GMM, asset allocation, portfolio choice

JEL Classification: C1, G1

Suggested Citation

Christie, Steve, Is the Sharpe Ratio Useful in Asset Allocation? (May 2, 2005). Macquarie Applied Finance Centre Research Paper, Available at SSRN: https://ssrn.com/abstract=720801 or http://dx.doi.org/10.2139/ssrn.720801

Steve Christie (Contact Author)

Macquarie University - Department of Applied Finance and Actuarial Studies ( email )

Room 732, Building E4A
North Ryde, NSW, 2109
Australia

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