What is the Sharpe Ratio, and how can everyone get it wrong?

TL;DR

This paper discusses the widespread misunderstandings of the Sharpe ratio in finance and aims to clarify its correct interpretation and application.

Contribution

It provides a critical analysis of common misconceptions about the Sharpe ratio and offers guidance to improve its proper use in finance.

Findings

Identifies prevalent errors in calculating the Sharpe ratio

Clarifies the correct interpretation of the Sharpe ratio

Provides recommendations for proper application

Abstract

The Sharpe ratio is the most widely used risk metric in the quantitative finance community - amazingly, essentially everyone gets it wrong. In this note, we will make a quixotic effort to rectify the situation.