TY - JOUR
AU - Goetzmann,William
AU - Ingersoll,Jonathan
AU - Spiegel,Matthew I.
AU - Welch,Ivo
TI - Sharpening Sharpe Ratios
JF - National Bureau of Economic Research Working Paper Series
VL - No. 9116
PY - 2002
Y2 - August 2002
DO - 10.3386/w9116
UR - http://www.nber.org/papers/w9116
L1 - http://www.nber.org/papers/w9116.pdf
N1 - Author contact info:
William N. Goetzmann
School of Management
Yale University
Box 208200
New Haven, CT 06520-8200
Tel: 203/432-5950
Fax: 203/432-3003
E-Mail: william.goetzmann@yale.edu
Matthew Spiegel
Yale School of Management
POB 208200
New Haven, CT 06520-8200
E-Mail: matthew.spiegel@yale.edu
Ivo Welch
Anderson School at UCLA (C519)
110 Westwood Place (951481)
Los Angeles, CA 90095-1482
E-Mail: ivo.welch@anderson.ucla.edu
AB - 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.
ER -