Sharpe ratio

The Sharpe ratio or reward-to-variability ratio is a financial ratio that measures the compensation (called a "risk premium") an investor receives for bearing an additional unit of risk. It is defined as

$S={\frac {E(r)-r_{f}}{\sigma }}$

where $E(r)$ is the asset's expected return, $r_{f}$ is the risk-free rate (normally, the rate of return of a United States T-bill) and $\sigma$ is the risk associated with the investment.

Development

The concept of a Sharpe ratio was first developed by William Sharpe, a professor of finance at Stanford University.