The Sharpe ratio was developed by Professor William Sharpe who won the Nobel Prize in Economics in 1990. The ratio measures risk-adjusted returns by subtracting the risk-free rate (usually represented by U.S. Government bonds) from the investment’s performance and then dividing the result by its standard deviation. The higher the ratio, the larger the performance for a given amount of risk.
The formula is:
Performance - risk-free investment rate / standard deviation
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