Calculating Sharpe Ratio for a Quality Minus Junk (QMJ) Factor Portfolio

[Nictorn]

Hello everyone,

I've recently constructed a zero-cost long-short portfolio based on the Quality Minus Junk (QMJ) factor. As I move forward with evaluating its performance, I've encountered a query regarding the calculation of the Sharpe Ratio for this portfolio.

Traditionally, the Sharpe Ratio is calculated as the difference between the portfolio return and the risk-free rate, divided by the standard deviation of the portfolio's excess returns. My question pertains to whether the risk-free rate should be subtracted from the QMJ factor returns in the numerator of this formula.

Given the nature of a zero-cost long-short portfolio like the QMJ, I'm uncertain if subtracting the risk-free rate makes sense in this context.

Could someone provide insights or guidance on how to appropriately calculate the Sharpe Ratio for a portfolio based on the QMJ factor?

Thank you in advance for your insights.

 

[lourano.x]

I think subtracting RF is a fundamental rule in finance, no matter what kind of portfolio you're constructing. It's all about seeing how much return you're making for the extra risk you take, compared to just keeping it safe.