How to Annualize a Sharpe Ratio

Sharpe Ratios are equal to the effective return divided by the standard deviation. Commonly, Sharpe Ratios on a daily, weekly or monthly basis are annualized by multiplying by the square root of the higher frequency time period. This is because

  • The effective return is proportional to time.
  • Assuming a Weiner process governs stock prices, variance is proportional to time. Hence standard deviation is proportional to the square root of time.

So you would scale a Sharpe Ratio by multiplying by t/√t = √t, where t is the frequency you are annualizing from. To summarize,

  • Monthly Sharpe Ratios are annualized by multiplying by √12
  • Daily Sharpe Ratios are annualized by multiplying by √252 (assuming 252 trading days in a year)

But (and this is a big but), a paper has demonstrated that this is misleading, and can often overestimate the actual Sharpe Ratio. The Sharpe Ratio is calculated from estimated quantities, and subject to errors. You have to take into account the specific properties of the returns distribution. For example, the Sharpe Ratio of hedge funds can be overestimated by 65% or more if you do not correctly model their serial autocorrelation.


2 thoughts on “How to Annualize a Sharpe Ratio

  1. Hello,
    I have constructed an Excel Sheet that calculates Sharpe, Sortino, Omega and Upside Potential ratios. For that I have used monthly returns of 100 months so far which is a pretty good sample in terms of size. However, I am very sceptical on how I should annualize all the above ratios which are monthly based. Is a simple multiplication by sqrt(12) the correct process ? I have 100 months of calculation and not 12 and also have not calculated any autocorrelation that might exist

  2. It’s truly a great and useful piece of information. I am glad that you shared this helpful information with us.
    Please keep us up to date like this. Thanks for sharing.

Leave a Reply

Your email address will not be published. Required fields are marked *

What is 4 + 11 ?
Please leave these two fields as-is:
IMPORTANT! To be able to proceed, you need to solve the following simple math (so we know that you are a human) :-)