7/23/2019 Week 9 Portfolio Performance Evaluation_color.7

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M2 Measure

It can be hard to interpret Sharpe Measure. If oneportfolio has a Sharpe ratio of 0.69 and another has aSharpe ratio of 0.73, what is the economic difference?

M2 helps make the Sharpe measure economicallyintuitive: Match volatility of the managed portfolio to that of the

index/portfolio which we are comparing to.

This can be done by creating a new imaginary portfolio, which

includes a positive/negative proportion of a risk free investment. If the managed portfolio has higher volatility than index, a positive

proportion invested in the risk-free rate will reduce volatility.

 M  P   r r  M      *

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