Portfolio Management

Sharpe's model

By
Dr. Ibha Rani
Kristu Jayanti College ( Autonomous)
 Sharpe’s Model
• The Performance measure of Portfolio developed by William Sharpe is
referred as Sharpe Ratio or Sharpe Index.
• Economist William F. Sharpe proposed the Sharpe ratio in 1966 as an
outgrowth of his work on the capital asset pricing model (CAPM), calling it the
reward-to-variability ratio.1
•  Sharpe won the Nobel Prize in economics for his work on CAPM in 1990.
• Sharpe Ratio is also used to carry out the performance of a particular
share against the risk. It can compare two different funds that possess the
same risk or same returns to help an investor understand how well he will
be compensated.
Higher Sharpe Ratio means greater returns from an investment at a higher level
 Formula of Sharpe Ratio
• The Sharpe Ratio is the difference between the risk-free return and the
return of an investment divided by the investment’s standard deviation.

• Sharpe Ratio=​Rp​−Rf / σp

• ​where:
• Rp​=return of portfolio
• Rf​=risk-free rate
• σp​=standard deviation of the portfolio’s excess return​
 Sharpe Ratio Risk Rate Verdict
•Less than 1.00 •Very low •Poor

•1.00 – 1.99 •high •Good

•2.00 – 2.99 •high •Great

•3.00 or above •high •Excellent

The above-given table shows the indicators of the good and bad Sharpe
Ratio. Investments having less than 1.00 do not generate higher investor
returns.
However, investments with Sharpe Ratio between 1.00 to 3.00 are
considered great Sharpe Ratio and investments above 3.000 are
considered excellent Sharpe Ratio.
Importance of Sharpe Ratio
• Sharpe Ratio in mutual funds plays a significant role in generating
returns and recognizing risk. It helps investors to identify the risk level
and adjusted return rate of all mutual funds.
• Analyze the fund’s performance
• Helps In Fund Comparison
• Investors Can Calculate the Risk Factor
• Study The Portfolio Diversification
Limitation of Sharpe Ratio
• 1) Sharpe Ratio of a fund does not take any responsibility for managing portfolio
risks and does not reveal whether the fund is dealing with single or multiple factors.
2) It considers all the investments to have a normal pattern for the dispersion of
returns, but funds may have different dispersion patterns.
3) The portfolio managers influence the Sharpe Ratio. They can try to boost their
risk-adjusted free returns by lengthening the time horizon for measuring the ratio.
4) Sharpe Ratio is used to evaluate a mutual fund which is considered not a good
strategy.