Comments on: Sortino Ratio

By: ted

ted — Fri, 13 Jun 2008 14:26:53 +0000

You can also increase the frequency of results to deal with the no downside deviation situation.

By: Michael

Michael — Tue, 11 Mar 2008 09:57:29 +0000

Did you upload the excel file for caluclating the sortino? Many thanks, M

By: Jay

Jay — Fri, 16 Nov 2007 19:43:26 +0000

Dan, you are correct in that a downside deviation of 0 would correspond to a Sortino Ratio of infinity. Conceptually, this is fine, however, when computing this mathematically, using computer software, this results in an error (#DIV/0! in Excel).
I, personally, have created adaptive-formula workarounds in Excel that vary the look-back period to the nearest historical point in time where the calculation of downside deviation yields a positive number. However, I haven’t yet formed an opinion as to whether I trust this or not because, in many respects, it’s like comparing apples to oranges. This is obvious because normally for historical-based data comparisons to be valid, certain things, such as look-back periods, need to be held to a constant. Normally, this might not be a problem unless you’re dealing with relatively short look-back periods that may actually have a 0 downside deviation.
Another “forced” modification of a formula is frequently used when calculating RSI, where there, too, a 0 in the denominator (representing an average down period of 0) would “force” the formula to resolve to a value of 100. So, conceptually, there are ways of dealing with this. I’m just sure the result is valid (except for things like RSI calcs, which by definition should result in “100″ when the average down period is 0).

By: Dan Hung

Dan Hung — Thu, 15 Nov 2007 17:00:33 +0000

I haven’t actually seen a situation where Sortino ratio is modified to account for a 0 downside deviaion so if you have an example you’d like to link. I’d be curious to see it.

In my mind, a downside deviation of 0 ought to correspond to a Sortino ratio of infinity. After all, the Sortino ratio is like alpha in that it tells you how you performed relative to some measure of risk. In this case, it assumes that the only kind of risk is risk to the downside as most of us would be okay with volatility that gives upside performance. In that sense, the Sortino ratio tells us that minimizing downside risk is every bit as important as return.

By: Jay

Jay — Thu, 15 Nov 2007 15:38:03 +0000

With respect to Alexander’s question of Nov. 9th, I, too, was interested in your answer, but from a different perspective. More to the point is that there may be periods (depending on the look-back period) when downside deviation itself is zero, which causes the denominator of the formula to be zero, which then of course causes the whole ratio to resolve to an incalculable number, which is infinity. I’ve never seen an adequate explanation or work-around to this problem, except a forced modification of the formula to accommodate these exceptions. I was wondering what your view was on this.