Which risk-adjusted performance measure uses the standard deviation in its denominator?

Which risk-adjusted performance measure uses the standard deviation in its denominator?

• A. Dollar-weighted return
• B. Time-weighted return
• C. Sharpe ratio
• D. Jensen's alpha

Answer: (C)

In risk-adjusted performance, you compare return to a measure of risk. The Sharpe ratio does this by taking the portfolio’s excess return over the risk-free rate and dividing it by the portfolio’s volatility, the standard deviation of its returns. This creates a payoff per unit of total risk, so standard deviation sits in the denominator. Dollar-weighted and time-weighted returns report how much was earned but don’t adjust by risk in the denominator. Jensen’s alpha adjusts for market risk using beta within the CAPM framework, not by using standard deviation in the denominator. So the measure that uses standard deviation in the denominator is the Sharpe ratio.

In risk-adjusted performance, you compare return to a measure of risk. The Sharpe ratio does this by taking the portfolio’s excess return over the risk-free rate and dividing it by the portfolio’s volatility, the standard deviation of its returns. This creates a payoff per unit of total risk, so standard deviation sits in the denominator. Dollar-weighted and time-weighted returns report how much was earned but don’t adjust by risk in the denominator. Jensen’s alpha adjusts for market risk using beta within the CAPM framework, not by using standard deviation in the denominator. So the measure that uses standard deviation in the denominator is the Sharpe ratio.