TITLE:
Reinterpreting the Sharpe Ratio as a Measure of Investment Return from Alpha
AUTHORS:
Michele Anelli
KEYWORDS:
Sharpe Ratio, Alpha Return
JOURNAL NAME:
Modern Economy,
Vol.14 No.2,
February
6,
2023
ABSTRACT: This paper examines the fundamental building blocks
of the Sharpe ratio to debate over the economic interpretation of this
well-known tool used to measure the risk-adjusted performance of various
financial portfolios and funds. It focuses on the risk-adjusted expected return
of an investment versus a benchmark portfolio (or index) return. By leveraging
on a set of statements and assumptions, I isolate the information content of
the ratio as expression of the investment return from alpha. I finally derive
that, under the efficient market hypothesis (EMH) or perfectly
diversified portfolios, the Sharpe ratio is zero.