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Lecture 11

BU473 Lecture Notes - Lecture 11: Sharpe Ratio, Discounted Cash Flow, Behavioral Economics

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David Cimon

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BU-473 Lecture 13
Portfolio Performance
Objective evaluation is important as it helps to overcome behavioral biases and make correct
Behavioral finance biases in investing
Rate of Return
Simplest measure of portfolio performance
Arithmetic average of holdings period returns:
Geometric Returns: Time-Weighted Average
Time weighted returns treat every period of the portfolio as equal
A common time-weighted return measure is the geometric average
 
IRR: Dollar-Weighted Average
This approach treats every dollar invested according to a discounted cash flow approach
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Sharpe Ratio
Simplest and most common measure of risk-adjusted return is the Sharpe ratio, which we have
encountered several times in this course already.
We’ve used the Sharpe ratio for a few different things:
o Defining an individual portfolio’s Capital Allocation Line.
o Finding the optimal tangency portfolio and market portfolio.
o Defining the market portfolio’s Capital Markets Line.
The realized Sharpe ratio of a portfolio given by:
On its own, Sharpe ratio is difficult to interpret
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