Alpha decay and Sharpe ratio: Two measures of investor performance

Ming Guo and Hui Ou-Yang

Economic Modelling, 2021, vol. 104, issue C

Abstract: We study alpha decay and the Sharpe ratio as two separate measures of investor performance in an infinite-horizon continuous-time model. In our model, an investor observes a mean-reverting signal which forecasts future stock returns but cannot be predicted by historical returns. This signal represents the investor's alpha, while its mean-reverting speed represents alpha decay. Overall, alpha decay and the Sharpe ratio have significantly different impacts on the investor's gross and net performance and his trading activities. Thus, we show that the relationship between an investor's performance and trading activities can be either positive or negative, which is consistent with the empirical evidence. Our model suggests measuring the performance of fund managers by both alpha decay and the Sharpe ratio in practice.

Keywords: Investor performance; The Sharpe ratio; Alpha decay; Trading activities; Transaction costs (search for similar items in EconPapers)
JEL-codes: D8 G11 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:104:y:2021:i:c:s0264999321001474

DOI: 10.1016/j.econmod.2021.105558

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