The Sharpe ratio was developed by Nobel laureate William F. Sharpe and is used to help investors understand the return of an investment compared to its risk.12 The ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. Volatility is a measure of the price fluctuations of an asset or portfolio.
Subtracting the risk-free rate from the mean return allows an investor to better isolate the profits associated with risk-taking activities. The risk-free rate of return is the return on an investment with zero risk, meaning it's the return investors could expect for taking no risk. The yield for a U.S. Treasury bond, for example, could be used as the risk-free rate.
Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return.
First one needs to estimate the risk free rate when it is composed of Fed taxes and interest charges. Our Fed is doing the trilemma, the bond market is distorted and the monopoly free risk rate has to be backed out from the various hedges that track the tax. The risk free is about two percent, after hedges are added in. Under the conditions we have today, many economists will foul this up though a few get it right.
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