Sortino ratio: A better measure of risk

 


In fact, for positively skewed return distributions, performance actually is achieved with less risk than the Sharpe ratio suggests. Ronald August 3, at 9:

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It is interesting to note that even Nobel laureate Harry Markowitz, when he developed Modern Portfolio Theory MPT in , recognized that because only downside deviation is relevant to investors, using it to measure risk would be more appropriate than using standard deviation.

However, he used variance the square of standard deviation in his MPT work because optimizations using downside deviation were computationally impractical at the time. In the early s, Dr.

Frank Sortino had undertaken research to come up with an improved measure for risk-adjusted returns. The first reference to the ratio was in Financial Executive Magazine August and the first calculation was published in a series of articles in the Journal of Risk Management September Standard deviation is a measure of dispersion of data around its mean, both above and below.

Target downside deviation is a measure of dispersion of data below some user-selectable target return with all above target returns treated as underperformance of zero. A better measure of risk.

To add comments, please log in or register. Sharpe ratio The Sharpe ratio is a metric that aims to measure the desirability of an investment by dividing the average period return in excess of the risk-free rate by the standard deviation of the return generating process. Sortino ratio In many ways, the Sortino ratio is a better choice, especially when measuring and comparing the performance of managers whose programs exhibit positive skew in their return distributions.

The Sortino ratio, S, is defined as: TDD is the target downside deviation. In the target downside deviation calculation, the deviations of Xi from the user selectable target return are measured, whereas in the Standard Deviation calculation, the deviations of Xi from the average of all Xi is measured.

In the target downside deviation calculation, all Xi above the target return are set to zero, but these zeros still are included in the summation. The calculation for Standard Deviation has no Min function.

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