The Treynor ratio, developed by Jack Treynor, one of the inventors of the Capital Asset Pricing Model (CAPM), is a measure used to evaluate the risk-adjusted return of an investment portfolio. It differs from the Sharpe ratio by using beta (market risk) instead of standard deviation (total risk) in its calculation. The Treynor ratio measures the excess return per unit of risk as represented by the portfolio's beta.
The Treynor ratio is particularly useful for comparing the performance of portfolios or funds with different levels of market risk. A higher Treynor ratio indicates a more favourable return on risk taken, suggesting better risk-adjusted performance.
When using the Treynor ratio, investors should remember that it is based on beta, which assumes a linear relationship between the portfolio’s returns and market returns. This ratio is most applicable to diversified portfolios where market risk is a primary concern. However, it may not provide a complete risk assessment for portfolios that are not well-diversified or are exposed to significant non-market risks.
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