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Return
Risk
Sharpe Ratio
is a pretty famous Risk adjusted return measure
Average Return
Risk-free rate
of return
Sharpe Ratio
Risk i.e. Standard
deviation of Return
Sharpe Ratio
The Sharpe Ratio is a very
standard measure to evaluate a
trading strategy
Sharpe Ratio
There are a few conventions
to how it is calculated
Sharpe Ratio
Sharpe Ratio
Sharpe Ratio
In the US, the risk-free rate of
return (from treasury bonds) ~ 0
Sharpe Ratio
Sharpe Ratio
The Sharpe ratio is normally
calculated using Annualized
Returns
Sharpe Ratio
First, lets consider the
relationship bet ween daily and
annual returns
Here is a time
series of price
data for the
NIFTY
Return = Ptoday/Pyest-1
We can compute
the average and
Standard deviation
for this series
1) Independent
2) Identically distributed
1) Independent
2) Identically distributed
IID
Mean = r
SD =
Mean = 252 *r
Mean = r
SD =
SD = 252 *
Going back to the Annualised
Sharpe
r
Assuming the
Daily Sharpe =
risk free rate =0
252*r
Annualised Sharpe =
252*
r
Daily Sharpe =
Annualised 252*r
Sharpe =
Annualised Sharpe =
252*r
Performance Measures
Return
Risk
Financial Markets
Trading Strategies
developed using
Mathematical Models
involves trading in
Financial Markets
Trading Strategies
developed using
Mathematical Models
involves trading in
Mathematical Models
A Quant trader
Mathematical Models
A Quant trader
Studies Historical Data
Identifies patterns in
security prices
Mathematical Models
A Quant trader
Studies Historical Data
Identifies patterns in security prices
Develops mathematical
models that capture these
patterns
Mathematical Models
A Quant trader
Studies Historical Data
Identifies patterns in security prices
Uses these
mathematical
models to
develop trading
strategies
Mathematical Models
There are generally 2 steps involved in
developing a trading strategy
Building a model
Testing the model
Backtesting
Building a model
This step answers one question
Building a model
The objective is to build a model
Historical
data
Model
Long/
Short
Mathematical Models
There are generally 2 steps involved in
developing a trading strategy
Building a model
Testing the model
Backtesting
Backtesting
Backtesting evaluates how the model
would have performed in the past
The return, risk, Sharpe Ratio are
calculated by applying the trading
strategy to past data
Backtesting
Backtesting is a standard way to
evaluate how well a trading
strategy might perform in reality