Question

Considering different measures of risk-adjusted return, what is the main difference between the Sharpe ratio and Treynor ratio? Why would you choose the Treynor ratio over the Sharpe ratio?

Answer 1

	Sharpe Ratio	Treynor Ratio
Formula	(Rp - Rf) / σ	(Rp - Rf) / b
Concept	It measure the return generated in excess of risk free return in relation to the Total risk (standard deviation) of portfolio	It measure the return generated in excess of risk free return in relation to the market beta(systematic risk)
Risk Considered	It considered both Systematic risk and Non Systematic risk	It is based on the premised that the unsystematic risk can be diverified and hence It considered only Systematic risk
For well diversified portfolio where there is no unsystematic risk, the treynor ratio is a good measure over the sharpe ratio as it calculated excess return per unit of market(systematic) risk. Therefore we should choose Treynor ratio over the sharpe ration for analysing a well diversified or market portfolio.