The excess return above the risk-free rate divided by the standard deviation of returns — a risk-adjusted performance measure expressing return per unit of volatility taken.
Deeper Explanation
A Sharpe ratio above 1.0 is generally considered good (more return per unit of risk than average); above 2.0 is excellent; above 3.0 is exceptional. Buffett's career Sharpe ratio is approximately 0.7 — seemingly modest, but extraordinarily persistent. The ratio has important limitations: it uses standard deviation (volatility) as the measure of risk, which penalises upside volatility equally with downside volatility. More importantly, it implicitly assumes returns are normally distributed — in practice, investment returns have fat tails, and strategies that appear to have high Sharpe ratios by "selling tail risk" (writing options, for example) can have catastrophically bad outcomes when the tail event materialises.
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