Annualize a monthly Sharpe of 0.35

Question

A fund's monthly returns give a Sharpe ratio of 0.35 per month. Assume 12 months per year and independent monthly returns. What is the annualized Sharpe ratio?

Accepted Answer

The scaling rule. Multiply the per-period Sharpe by the square root of the number of periods per year: SR{	ext{annual}} = SR{	ext{period}} 	imes \sqrt{k}. Here k = 12 months. Why the square root. Over 12 independent months, the average return adds up by a factor of 12, but the volatility grows only by \sqrt{12}. Since Sharpe is return over volatility, it scales by 12/\sqrt{12} = \sqrt{12}. Plug in the numbers. SR{	ext{annual}} = 0.35 	imes \sqrt{12} = 0.35 	imes 3.464 \approx 1.21. Interpretation. A monthly Sharpe of 0.35 annualizes to about 1.21. This is the standard convention for hed…

Annualize a monthly Sharpe of 0.35

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