The implied Sharpe ratio

DOI10.1080/14697688.2020.1718194MaRDI QIDQ5139210zbMATH OpenOpenAlexFDO

Authors Ankush Agarwal, Matthew Lorig

Publication date 7 December 2020

Published in Quantitative Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1908.04837, http://eprints.gla.ac.uk/207819/7/207819.pdf

zbMATH Keywords

HestonPDE asymptoticsreciprocal HestonSharpe ratiostochastic volatility

Mathematics Subject Classification ID

Portfolio theory (91G10) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: In an incomplete market, including liquidly-traded European options in an investment portfolio could potentially improve the expected terminal utility for a risk-averse investor. However, unlike the Sharpe ratio, which provides a concise measure of the relative investment attractiveness of different underlying risky assets, there is no such measure available to help investors choose among the different European options. We introduce a new concept -- the implied Sharpe ratio -- which allows investors to make such a comparison in an incomplete financial market. Specifically, when comparing various European options, it is the option with the highest implied Sharpe ratio that, if included in an investor's portfolio, will improve his expected utility the most. Through the method of Taylor series expansion of the state-dependent coefficients in a nonlinear partial differential equation, we also establish the behaviour of the implied Sharpe ratio with respect to an investor's risk-aversion parameter. In a series of numerical studies, we compare the investment attractiveness of different European options by studying their implied Sharpe ratio.

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Cites work

• A closed-form solution for options with stochastic volatility with applications to bond and currency options
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Cited in

(7)

• A robust Sharpe ratio
• Implied risk aversion: an alternative rating system for retail structured products
• Portfolio optimization under local-stochastic volatility: coefficient Taylor series approximations and implied Sharpe ratio
• Generalised Sharpe Ratios and Asset Pricing in Incomplete Markets *
• Stock performance by utility indifference pricing and the Sharpe ratio
• The strategy approval decision: a Sharpe ratio indifference curve approach
• The trade-off frontier for ESG and Sharpe ratio: a bootstrapped double-frontier data envelopment analysis

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