EconPapers    
Economics at your fingertips  
 

Proper use of the modified Sharpe ratios in performance measurement: rearranging the Cornish Fisher expansion

Charles-Olivier Amédée-Manesme () and Fabrice Barthélémy
Additional contact information
Charles-Olivier Amédée-Manesme: Université Laval
Fabrice Barthélémy: Université de Versailles Saint-Quentin-en-Yvelines

Annals of Operations Research, 2022, vol. 313, issue 2, No 5, 712 pages

Abstract: Abstract Performance analysis is a key process in finance to evaluate or compare investment opportunities, allocations, or management. The classical method is to compute the market or sub-market returns and volatilities, and then calculate the standard performance measure, namely, the Sharpe ratio. This measure is based on the first two moments of a return distribution. Therefore, a significant weakness of this method is that it implicitly assumes that the distribution is Gaussian (if it is not Gaussian, the approach may lead to a bad fit). In fact, risk comes from not only volatility, but also from higher moments of distribution such as skewness and kurtosis. The standard method to resolve this issue is to use the modified Sharpe ratio; this method replaces the classical Sharpe ratio volatility with the value at risk. The latter is computed using the Cornish Fisher expansion, a tool based on the first four moments of return distribution. This methodology, however, may present a major pitfall: in some cases, quantile functions do not stay monotone. In this paper, we show how this tool can be used effectively through a specific procedure, rearrangement. We compare various metrics using rank correlation, and demonstrate how and in which cases the proposed procedure delivers ranking different from the standard Sharpe ratio ranking. Furthermore, we show how our technique offers better distribution approximations and is therefore a more useful performance metric. Institutional investors may find the technique proposed here useful in that it allows for considering non-normality in performance analysis.

Keywords: Performance measures; Cornish Fisher expansion; Modified Sharpe ratio; Rearrangement (search for similar items in EconPapers)
JEL-codes: C69 G00 G11 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
http://link.springer.com/10.1007/s10479-020-03858-4 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:annopr:v:313:y:2022:i:2:d:10.1007_s10479-020-03858-4

Ordering information: This journal article can be ordered from
http://www.springer.com/journal/10479

DOI: 10.1007/s10479-020-03858-4

Access Statistics for this article

Annals of Operations Research is currently edited by Endre Boros

More articles in Annals of Operations Research from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().

 
Page updated 2022-07-30
Handle: RePEc:spr:annopr:v:313:y:2022:i:2:d:10.1007_s10479-020-03858-4