The risk-return ratio is a measure of
return
Return may refer to:
In business, economics, and finance
* Return on investment (ROI), the financial gain after an expense.
* Rate of return, the financial term for the profit or loss derived from an investment
* Tax return, a blank document or t ...
in terms of
risk
In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty about the effects/implications of an activity with respect to something that humans value (such as health, well-being, wealth, property or the environm ...
for a specific time period. The percentage return (R) for the time period is measured in a straightforward way:
:
where
and
simply refer to the price by the start and end of the time period.
The risk is measured as the percentage
maximum drawdown (MDD) for the specific period:
:
where ''DD
t'', ''DD''
''t''-1, ''P
t'' and ''P''
''t''-1 refer the drawdown (''DD'') and prices (''P'') at a specific point in time, ''t'', or the time right before that, ''t''-1.
The risk-return ratio is then defined and measured, for a specific time period, as:
:
Note that dividing a percentage numerator by a percentage
denominator
A fraction (from la, fractus, "broken") represents a part of a whole or, more generally, any number of equal parts. When spoken in everyday English, a fraction describes how many parts of a certain size there are, for example, one-half, eight ...
renders a single number. This RRR number is a measure of the return in terms of risk. It is fully comparable, i.e. it's possible to compare the RRR for one share with the RRR of another share, just as long as it's the same time period.
The RRR as defined here is formally the same as the so-called MER ratio, and shares some similarities with the
Calmar ratio, the
Sterling ratio and the Burke ratio. However, the RRR can arguably be regarded as more general than the MER ratio since it can be used for any time interval even daily or intra-day prices, while the MER ratio seems to be confined to measuring only the risk and return of a fund since inception until the current date. It is also less ad hoc than the Calmar, the Sterling and the Burke ratios.
The RRR was first defined and popularized by Dr. Richard CB Johnsson in his investment newsletter ('A Simple Risk-Return-Ratio', July 25, 2010).
References
{{reflist
* Johnsson, Richard CB
A Simple Risk-Return-Ratio
Financial ratios
Investment indicators