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Implications of the Sharpe ratio as a performance measure in multi-period settings

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  • Cvitanic, Jaksa
  • Lazrak, Ali
  • Wang, Tan

Abstract

We study effects of using Sharpe ratio as a performance measure for compensating money managers in a dynamic market. We demonstrate that the manager's focus on the short horizon is detrimental to the long-horizon investor. When the returns are iid, the performance loss is significant, even when horizons are not very different. When the returns are mean reverting, the performance loss is exacerbated. We show that the manager's strategy tends to increase (decrease) the risk in the latter part of the optimization period after a bad (good) performance in the earlier part of the period, in agreement with empirical observations.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 32 (2008)
Issue (Month): 5 (May)
Pages: 1622-1649

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Handle: RePEc:eee:dyncon:v:32:y:2008:i:5:p:1622-1649

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Web page: http://www.elsevier.com/locate/jedc

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  18. Jaksa Cvitanic & Fernando Zapatero, 2004. "Introduction to the Economics and Mathematics of Financial Markets," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262532654, January.
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Cited by:
  1. Anthony Tay, 2008. "Time-Varying Incentives in the Mutual Fund Industry," Finance Working Papers 22484, East Asian Bureau of Economic Research.
  2. Lioui, Abraham, 2013. "Time consistent vs. time inconsistent dynamic asset allocation: Some utility cost calculations for mean variance preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 37(5), pages 1066-1096.
  3. Basak, Suleyman & Chabakauri, Georgy, 2009. "Dynamic Mean-Variance Asset Allocation," CEPR Discussion Papers 7256, C.E.P.R. Discussion Papers.
  4. Olivier, Jacques & Tay, Anthony, 2008. "Time-Varying Incentives in the Mutual Fund Industry," CEPR Discussion Papers 6893, C.E.P.R. Discussion Papers.

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