The Performance Measurement of Generalized Sharpe Ratio and Economic Performance Measure: A Hedge Funds Example

Abstract

Prior literature documents that the Sharpe ratio (SR) generates biases in performance evaluation if returns distribution deviates from normal distribution because SR is derived under the mean-variance model with the strict assumption of either quadratic preferences or customarily distributed returns. When the return distributions deviate from normality, it may lead to unreasonable results. Therefore, this study examines which performance measurement approaches are efficient for non-normality on the distribution of asset returns. We collect monthly returns of 14 Credit Suisse (CS) hedges fund indexes from April 1994 to June 2021. The hedge fund index returns exhibit high negative skewness or high positive kurtosis, implying non-normal distribution. Then, we employ the Sharpe ratio (SR) and two performance measures, which extend the Sharpe ratio, the generalized Sharpe ratio (GSR), and the economic performance measure (EPM), to evaluate the performances of hedge funds. In addition, both the nonparametric and parametric estimation methods of the GSR and the EPM are utilized. Our findings indicate that the nonparametric GSR and the nonparametric EPM produce more similar rankings than the SR. Among the three parametric estimation methods of the GSR and EPM, only the method proposed by [1] produces similar rankings with the nonparametric GSR and the nonparametric EPM. Finally, our study contributes the practical approach for fund managers to evaluate their fund performance efficiently.