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Alpha decay and Sharpe ratio: Two measures of investor performance

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  • Guo, Ming
  • Ou-Yang, Hui

Abstract

We study alpha decay and the Sharpe ratio as two separate measures of investor performance in an infinite-horizon continuous-time model. In our model, an investor observes a mean-reverting signal which forecasts future stock returns but cannot be predicted by historical returns. This signal represents the investor's alpha, while its mean-reverting speed represents alpha decay. Overall, alpha decay and the Sharpe ratio have significantly different impacts on the investor's gross and net performance and his trading activities. Thus, we show that the relationship between an investor's performance and trading activities can be either positive or negative, which is consistent with the empirical evidence. Our model suggests measuring the performance of fund managers by both alpha decay and the Sharpe ratio in practice.

Suggested Citation

  • Guo, Ming & Ou-Yang, Hui, 2021. "Alpha decay and Sharpe ratio: Two measures of investor performance," Economic Modelling, Elsevier, vol. 104(C).
    • Handle: RePEc:eee:ecmode:v:104:y:2021:i:c:s0264999321001474
    DOI: 10.1016/j.econmod.2021.105558
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    More about this item

    Keywords

    Investor performance; The Sharpe ratio; Alpha decay; Trading activities; Transaction costs;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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