What does the Sharpe ratio measure?

The Sharpe ratio is a widely used measure in the field of finance that quantifies the return of an investment relative to its risk. Specifically, it calculates the excess return, which is the return of the investment above the risk-free rate, and divides it by the investment's standard deviation, which represents the risk or volatility of the investment. This ratio effectively assesses how well the return compensates the investor for the risk taken. A higher Sharpe ratio indicates that the investment has provided a better return for the level of risk assumed, making it a valuable tool for comparing different investment options and portfolios.

In contrast, measuring the risk of an entire market does not capture the specifics of individual investments and is not the focus of the Sharpe ratio. The historic performance of specific stocks deals with past returns without adjusting for risk, thus not aligning with the intentions of the Sharpe ratio. Lastly, total investment fees are relevant for evaluating costs but do not consider the relationship between risk and return that the Sharpe ratio emphasizes. Overall, the measurement of excess return per unit of risk is at the core of what the Sharpe ratio seeks to convey.