Beware the Sharpe Ratio
10 Pages Posted: 2 Jan 2007
Date Written: January 2, 2007
Investors often consider Sharpe ratios when making portfolio decisions. Given sampling error in estimated means and variances of returns, simplistic use of Sharpe ratios when choosing between portfolios is extremely ill-advised. In practice, the error in the estimate of the Sharpe ratio will almost certainly be too large to distinguish between the Sharpe ratios of two portfolios. The information ratio suffers similar deficiencies. This is a very short, easy-read summary of longer research papers by the author on the topic.
Keywords: Sharpe ratio, estimation error, GMM, asset allocation, portfolio choice, information ratio
JEL Classification: C1, G1
Suggested Citation: Suggested Citation