What are the limitations of the Sharpe Ratio?
An example of an AI chatbot conversation about the limitations of the Sharpe Ratio in finance.
What are the limitations of the Sharpe Ratio?
The Sharpe Ratio is a popular measure of risk-adjusted return, but it has several limitations. For instance, it assumes that returns are normally distributed, which is not always the case in real markets.
Can you explain why the normal distribution assumption is a problem?
Sure! The normal distribution assumption can be problematic because financial returns often exhibit skewness and kurtosis, meaning they can have extreme values or outliers that the Sharpe Ratio doesn't account for.
What are some alternatives to the Sharpe Ratio?
Alternatives include the Sortino Ratio, which focuses on downside risk, and the Omega Ratio, which considers all moments of the return distribution.
How can I calculate the Sortino Ratio?
To calculate the Sortino Ratio, subtract the target return from the portfolio return, then divide by the downside deviation of the portfolio returns.
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