What Risk-Free Rate does Finzig use to calculate the Sharpe Ratio?

The risk-free rate represents the return on an investment with zero risk of financial loss. It serves as a benchmark for comparing the performance of other investments. The rate is often based on the returns of government securities such as the U.S. Treasury bills (T-Bill), which are considered risk-free.

The Sharpe ratio is calculated as:

$$\text{Sharpe Ratio} = \frac{R_p - R_f}{\sigma_p}$$

Where:

• $R_p$ is the return of the portfolio or security.
• $R_f$ is the risk-free rate.
• $\sigma_p$ is the standard deviation of the portfolio's excess return (i.e. the volatility).

For our backtesting tool, Finzig uses a risk-free rate of 0%. This simplifies the calculation and focuses on the raw performance of your investment portfolio. By using a 0% risk-free rate, the Sharpe ratio formula becomes:

$$\text{Sharpe Ratio} = \frac{R_p}{\sigma_p}$$

This approach helps you easily understand the relationship between your portfolio's return and its risk, without adjusting for an external risk-free benchmark.

Using a 0% risk-free rate emphasizes the pure return per unit of risk, providing a straightforward comparison of different investment strategies within the Finzig backtesting tool.