The Sortino ratio is a measure of a risk-adjusted return of an investment asset. It is an extension of the Sharpe ratio. While Sharpe ratio takes into account any volatility in return of an asset, Sortino ratio differentiates volatility due to up and down movements. The up movements are considered desirable and not accounted in the volatility. The Sharpe ratio is a measure of risk-adjusted performance of an investment asset, or a trading strategy. ... Volatility is the standard deviation of the change in value of a financial instrument with a specific time horizon. ...
That is, the Sortino ratio does not penalize a fund for its upside volatility. The ratio is calculated as
where < R > is the expected value of asset return, Rf is an expected return of another "standard" asset, such as the risk free rate of return, and σd is the standard deviation of the negative asset returns. In probability theory (and especially gambling), the expected value (or mathematical expectation) of a random variable is the sum of the probability of each possible outcome of the experiment multiplied by its payoff (value). Thus, it represents the average amount one expects to win per bet if bets with identical... The risk-free interest rate is the interest rate that it is assumed can be obtained by investing in financial instruments with no risk. ... In probability and statistics, the standard deviation is the most commonly used measure of statistical dispersion. ...
The Sortinoratio also uses the excess returns for the numerator; however, the Sortinoratio acknowledges that not all deviation from the mean is unacceptable for investors.
Using the Sortinoratio, lump-sum investing is the preferred investing strategy for all asset classes with the exception of government bonds, whereas the UPR ranks value averaging as the preferred investing strategy for all assets with the exception of small-cap stocks.
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