RFS Advance Access originally published online on August 25, 2008
Review of Financial Studies 2009 22(7):2571-2606; doi:10.1093/rfs/hhn081
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New Measures for Performance Evaluation
Department of Probability Theory, Faculty of Mechanics and Mathematics, Moscow State University
Robert H. Smith School of Business, Van Munching Hall, University of Maryland
Send correspondence to Dilip Madan, e-mail: DMadan{at}rhsmith.umd.edu
JEL Classification: G10, G13, G14
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Abstract |
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This paper characterizes performance measures satisfying a set of proposed axioms. We develop four new measures consistent with the axioms and show that they improve on the economic properties of the Sharpe Ratio and the Gain-Loss Ratio. In our treatment, the performance measures, or the indexes of acceptability, are linked to positive expectations resulting from a stressed sampling of the cash-flow distribution. Theoretically, it is shown that the level of acceptability varies directly with the amount of stress tolerated. In an empirical application, the performance measures are applied to cash flows generated by writing options on the SPX and the FTSE. This exercise reveals that acceptability levels are U-shaped in the strike direction.
An earlier version of this article was entitled "On Measuring the Degree of Market Efficiency." We are grateful to two anonymous referees for a very careful reading of the manuscript and a number of valuable remarks and suggestions that enabled us to improve the quality of the paper. We thank the participants of the Global Derivatives Conference Paris, Second AMaMeF Conference, Stanford-Tsukuba Workshop, and Third Annual Meeting of CARISMA London, seminar participants at the universities of Columbia, Cornell, Florida, New York, North Carolina, Maryland, Princeton, and Stanford, as well as our colleagues from Bloomberg and Derivatives Technologies Foundation Amsterdam for helpful comments and discussions. Special thanks are to Gurdip Bakshi for very valuable comments and suggestions.