Some Results on Bivariate Squared Maximum Sharpe Ratio

Abstract

The Sharpe ratio is a widely used tool for assessing investment strategy performance. An essential part of investing involves creating an appropriate portfolio by determining the optimal weights for desired assets. Before constructing a portfolio, selecting a set of investment opportunities is crucial. In the absence of a risk-free asset, investment opportunities can be identified based on the Sharpe ratios of risky assets and their correlation. The maximum squared Sharpe ratio serves as a useful metric that summarizes the performance of an investment opportunity in a single value, considering the Sharpe ratios of assets and their correlation coefficients. However, the assumption of a normal distribution in asset returns, as implied by the Sharpe ratio and related metrics, may not always hold in practice. Non-normal returns with a non-linear dependence structure can result in an overestimation or underestimation of these metrics. Copula functions are commonly utilized to address non-normal dependence structures. This study examines the impact of asset dependence on the squared maximum Sharpe ratio using copulas and proposes a copula-based approach to tackle the estimation issue. The performance of the proposed estimator is illustrated through simulation and real-data analysis.