Sharpe Ratio

The Sharpe ratio compares the return of an investment with its risk. 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.

Economist William F. Sharpe proposed the Sharpe ratio in 1966, which he referred to as the reward-to-variability ratio. This ratio developed from his work on the capital asset pricing model (CAPM). In 1990, Sharpe was awarded the Nobel Prize in Economics for his contributions to CAPM.

The Sharpe ratio's numerator is the difference over time between realised or expected returns and a benchmark, such as the risk-free rate of return or the performance of a particular investment category. Its denominator is the standard deviation of returns over the same period, a measure of volatility and risk.