Relative Dispersion: Amount of dispersion relative to a reference value or

benchmark.
Coefficient of Variation Formula. The coefficient of variation CV is the
ratio of the standard deviation of a set of observations to their mean value.

S = the sample standard deviation

X = the sample mean
When observations are returns, the coefficient of variation measures the
amount of risk (standard deviation) per unit of mean return.
CV is a scale-free measure, therefore, it has no units of measurement.

The Sharpe Ratio

The inverse of the CV reveals something about return per unit of risk
because the standard deviation of returns is commonly used as a measure
of investment risk
A more precise return-risk measure recognizes the existence of a risk-free
return, a return for virtually zero standard deviation. With a risk free asset,
an investor can choose a risk portfolio, and then combine that portfolio with
the risk-free asset to achieve any desired level of absolute risk as measured
by standard deviation of return, sp.
Sharpe Ratio Formula for a portfolio p, based on historical returns is defined
as:

Where Rp is the mean return to the portfolio, Rf is the

mean return to a risk-free asset, and sp is the standard deviation of return
on the portfolio.
The numerator measures the extra reward that investors receive for the
added risk taken. (Mean excess return), And gives a result of per unit of risk.
Risk averse investors who invest based on mean return and standard
deviation, prefer portfolios with larger Sharpe ratios.
It fails when the returns are negative (for example, returns over bear market
periods). Therefore in this situation we must find a larger period with
positive returns., or find other metric.

Conceptual limitation: doesnt count asymmetric returns, and infrequent but

extremely large losses. Calculated over a period in which the strategy is
woking (not big loss yet) this type of strategy would have a high Sharpe
ratio, and would give optimistic picture of risk adjusted performance
because standard deviation would incompletely measure the risk assumed.
So we should evaluate whether standard deviation adequately describes the
risk of the mangers investment strategy.
SYMETRY AND SKEWNESS IN RETURN DISTRIBUTIONS
Mean and variance may not adequately describe an investments
distribution of returns. In calculations of variance, for ex, the deviations
around the mean are squared, so we do not know whether large deviations
are likely to be positive or negative.
We need to go beyond measures of central tendency and dispersion to
reveal other characteristics of the distribution.
Return distributions is symmetrical about its mean, each side of the
distribution is a image of the other.
For ex, loses of -5% occur about the same frequency as gains from 5%.
The normal distribution is the most important distribution. Characteristics:
-

Its mean and median are equal

Completely described by two parameters, mean and variance.
Almost 68% of its observations lie between plus and minus one SD
from the mean. 95% lie between two SD, and 99% between three SD.

A distribution not symmetrical is called skewed. A return distribution with

positive skew has frequent small losses and a few extreme gains, unimodal
distribution, and the mode is less than the median, which is less than the
man. The inverse in the negative.

The principle behind the measure by focusing on the numerator. Cubing

preserves the sign of the deviations from the mean. If a distribution is
positively skewed with a mean greater than its median, then more than half
of the deviations from the mean are negative and less than half are positive.
In order for the sum to be positive, the losses must be small and likely, and
the gains less likely but more extreme.

KURTOSIS IN RETURN DISTRIBUTIONS

Another way in which a return distribution might differ from a normal
distribution is by having more returns clustered closely around the mean
(being more peaked) and more returns with large deviations from the mean
(having fatter tails).
Relative to a normal distribution, such a distribution has greater percentage
of extremely large deviations from the mean return.
Kurtosis is the statistical measure that tells us when a distribution is more
or less peaked than a normal distribution. A distribution that is more peaked
than normal is called leptokurtic and a distribution that is less peaked than
normal is called platykurtic. A distribution identical to the normal
distribution in this respect is called mesokurtic.

USING GEOMETRIC AND ARITHMETIC MEANS

For reporting historical returns, the geometric mean has considerable appeal
because it is the rate of growth or return we would have had to earn each
year to match the actual, cumulative investment performance.
The geometric mean is an excellent measure of past performance.
The arithmetic mean is always greater than or equal to the geometric mean.
If we want to estimate the average return over a one-period horizon, we
should use the arithmetic mean because the arithmetic mean is the average
of one-period returns.
On the other hand, if we want to estimate the average returns over more
than one period, we should use the geometric mean of returns because the
geometric mean captures how the total returns are linked over time.