NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Sharpening Sharpe Ratios

William Goetzmann, Jonathan Ingersoll, Matthew I. Spiegel, Ivo Welch

NBER Working Paper No. 9116
Issued in August 2002
NBER Program(s):   AP

It is now well known that the Sharpe ratio and other related reward-to-risk measures may be manipulated with option-like strategies. In this paper we derive the general conditions for achieving the maximum expected Sharpe ratio. We derive static rules for achieving the maximum Sharpe ratio with two or more options, as well as a continuum of derivative contracts. The optimal strategy rules for increasing the Sharpe ratio. Our results have implications for performance measurement in any setting in which managers may use derivative contracts. In a performance measurement setting, we suggest that the distribution of high Sharpe ratio managers should be compared with that of the optimal Sharpe ratio strategy. This has particular application in the hedge fund industry where use of derivatives is unconstrained and manager compensation itself induces a non-linear payoff. The shape of the optimal Sharpe ratio leads to further conjectures. Expected returns being held constant, high Sharpe ratio strategies are, by definition, strategies that generate regular modest profits punctunated by occasional crashes. Our evidence suggests that the 'peso problem' may be ubiquitous in any investment management industry that rewards high Sharpe ratio managers.

download in pdf format
   (1322 K)

email paper

This paper is available as PDF (1322 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w9116

Users who downloaded this paper also downloaded these:
Lehmann and Modest w1721 Mutual Fund Performance Evaluation: A Comparison of Benchmarks and Benchmark Comparisons
Goetzmann and Kumar w8686 Equity Portfolio Diversification
Bond, Edmans, and Goldstein w17719 The Real Effects of Financial Markets
Henry and Kannan Growth and Returns in Emerging Markets
Perraudin and Vitale Interdealer Trade and Information Flows in a Decentralized Foreign Exchange Market
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us