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

by OC1143910

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Portfolio Performance

• Objective evaluation is important as it helps to overcome behavioral biases and make correct

decisions

• 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

• IRR:

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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