Module 50.3 LOS 50.d: Using the Information Ratio and Sharpe Ratio

Investors are said to choose some combination of the risk-free asset and an optimal risky portfolio. The weights will be determined by risk preference. A few other takeaways from portfolio theory are that the optimal risky portfolio is the one with the highest Sharpe ratio, and this portfolio will also have the highest information ratio. This will be the best active portfolio for all investors regardless of risk tolerance.

The information ratio can be used to determine the expected active return for a given target level of active risk:

E(RA) = IR × σA

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