Sharpe(new) * Sharpe(current)* correlation 2011, current, between

lxwarr30

When you consider adding new securities into current portfolio, is it feasible to apply this concept in reality?

If yes, how to calculate the sharpe ratio, and correlation between current portfolio and new securities?

Thanks.



Edited 1 time(s). Last edit at Tuesday, June 21, 2011 at 09:35AM by Siesta.

bleach

I find it to be a useful rule of thumb: if you want to increase the Sharpe of your portfolio, a small allocation to a new asset would increase the portfolio Sharpe as long as Sharpe of the new asset is greaterer than the product of the portfolio Sharpe and the correlation. Some of the questions you need to answer are:

1) What is your investment objective? (For example, if it's information ratio, you can derive a similar rule that includes information ratio instead of Sharpe. Or maybe due to some constraints you can't leverage up your portfolio and you really care about expected return rather than Sharpe, etc).

2) How to estimate the Sharpe ratios and correlations?
You can look at historical results and particularly look at observed ranges of values. Be cautious of unsustainable performance.

3) What are the expected ranges of the parameters and how sensitive is your decision to include a new security (asset, etc) on the parameters? For example, if you expect that your portfolio Sharpe is between 0.5 and 1, a low correlated asset (correlation below 0.3) would add value under all scenarios as long as its Sharpe is above 0.3 whereas a highly correlated asset would have to have a much higher Sharpe.

Is that helpful?

thecfawannabe

You continue to add a security if the ending portfolio sharpe is greater than beginning portfolio sharpe.

The securities sharpe ratio doesn't have to be greater than your portfolio sharpe for you to add it, it depends on the covariance/correlation.

AnalystForum

Please be careful with that => sharpe ratio, and correlation

If you add more securities into ur PF, correlation is included into the new Sharpe ratio calculated as u have updated expected portfolio variance with the new sec.

The Sharpe ratio may be higher because:
1. new expected PF variance is lower while other factors remaining constant
1. new expected PF return is higher while other factors remaining constant

Sharpe ratio only tells you that if SR2 > SR1 => Expected risk adjusted return is improved

Nevertheless, be careful with variance as a risk measure as it implies returns are normally distributed



Edited 1 time(s). Last edit at Tuesday, June 21, 2011 at 11:30AM by Fridge.