The Strategy Approval Decision: A Sharpe Ratio Indifference Curve Approach

The strategy approval decision: A Sharpe ratio indifference curve approach

The problem of capital allocation to a set of strategies could be partially avoided or at least greatly simplified with an appropriate strategy approval decision process. This paper proposes such procedure. We begin by splitting the capital allocation problem into two sequential stages: Strategy approval and portfolio optimization. Then we argue that the goal of the second stage is to beat a na...

The Sharpe Ratio Indifference Curve

The Sharpe Ratio and Preferences: a Parametric Approach

We use a log-normal framework to examine the effect of preferences on the market price for risk, that is, the Sharpe ratio. In our framework, the Sharpe ratio can be calculated directly from the elasticity of the stochastic discount factor with respect to consumption innovations as well as the volatility of consumption innovations. This can be understood as an analytical shortcut to the calcula...

Inference for the Sharpe Ratio Using a Likelihood-Based Approach

The Sharpe ratio is the prominent risk-adjusted performance measure used by practitioners. Statistical testing of this ratio using its asymptotic distribution has lagged behind its use. In this paper, highly accurate likelihood analysis is applied for inference on the Sharpe ratio. Both the oneand two-sample problems are considered. The methodology has O n−3/2 distributional accuracy and can be...

The Sharpe Ratio Efficient Frontier

We evaluate the probability that an estimated Sharpe ratio exceeds a given threshold in presence of non-Normal returns. We show that this new uncertainty-adjusted investment skill metric (called Probabilistic Sharpe ratio, or PSR) has a number of important applications: First, it allows us to establish the track record length needed for rejecting the hypothesis that a measured Sharpe ratio is b...