The Sharpe Ratio is a measure of risk-adjusted performance that indicates how much excess return an investment generates per unit of risk taken. It was developed by Nobel laureate William Sharpe.
The formula is: Sharpe Ratio = (Rp - Rf) / σp, where Rp is the portfolio return, Rf is the risk-free rate, and σp is the standard deviation of portfolio returns.
A higher Sharpe Ratio indicates better risk-adjusted returns. For example, a Sharpe Ratio of 1.5 means the investment generates 1.5 units of excess return for every unit of risk. Generally, a ratio above 1.0 is considered good, above 2.0 is very good, and above 3.0 is excellent. Investors use the Sharpe Ratio to compare different investments on a risk-adjusted basis.