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Your interpretation of the Sharpe ratio suffers from
the common misunderstanding why and how Sharpe ratio
works.
In short, the measure of upside volty is a necessary
component because you want to know how fast a trading
model or a trader "bounce" from their drawndown.
Sharpe ratio is a proper measure of the risk reward behaviour.
If you need to measure downside risk, try something else
that measure aspects of drawdown in more details.
-Lawrence
--- Virgin Trader <virgin_trader@xxxxxxxxxxx> wrote:
> Although the Sharpe Ratio is widely recognised as a measure of the
> volatility of strategy performance, it arguably suffers from the fact that
> it includes upside volatility in it's calculation, as well as downside.
>
> Since we are principally interested in (the limitation of) drawdowns rather
> than the volatility of favourable equity excursions, it would seem to make
> some sense to exclude upside volatility from such a calculation, which, I
> understand, is what the Return Retracement Ratio does (although I haven't
> seen the formula for it - perhaps someone could tell me what it is).
>
> My problem though, is that I cannot quite convince myself that the
> statistics of upside volatility are necessarily unrelated to those of
> downside volatility, depending on the characteristics of the system being
> tested. In other words, if a backtested system has shown greater upside
> volatility than downside in the past, how much trust could you give to the
> notion that the ratio (of upside to downside volatility) might continue in a
> similar way in the future? Can you be confident that upside volatility is
> not also a valid predictor of downside volatility as well?
>
> These are not rhetorical questions -the more I think about it the less
> convinced I become one way or the other.
>
> Unfortunately I have seen almost nothing on the Return Retracement Ratio
> and it's advantages or disadvantages vis a vis the Sharpe Ratio. If some
> kind soul could point me towards some relevant resource or share their own
> thoughts I would appreciate it.
>
> VT
>
=====
Lawrence Chan http://www.tickquest.com
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