Sortino Ratio

[ravishankar80]

Hi David,

Regarding Sortino ratio I am not clear on what the denominator represents. Went through Wikipedia and it saysdenominator is the downside risk
"The downside risk is the target semideviation = square root of the target semivariance (TSV). TSV is the return distribution's lower-partial moment of degree 2 (LPM2)."

FRM 2008 practice question says "Semi standard deviation" . What I wanted to understand is why is Sortino ratio used? Is it for that are not well diversified ? What does the denominator represent?

Regards
Ravi

 

[David Harper CFA FRM]

Hi Ravi,

(sorry for delay on this one)

I think that practice question is imprecise. Sortino is like Sharpe but riskless rate is replaced with Minimum Acceptable Return (MAR). So it is (excess return above MAR)/(standard deviation of returns below MAR). Where MAR is any benchmark, and could include riskless rate. This is a typical "downside risk" measure so the point is to use it for asymmetrical returns and have it look only at the downside; b/c Sharpe ratio & volatilty count the upside, too, but is not risk for us...David