hard · Frm Part 2 Risk & Investment Management
According to the 'Peso Problem' in performance measurement, why might a high Sharpe ratio be misleading for a strategy like merger arbitrage or carry trades?
- The calculation uses the wrong risk-free rate benchmark.
- The strategy is market-neutral and thus should have a Sharpe ratio of zero.
- The strategy harvests small steady gains but carries rare, catastrophic tail risk that may not appear in the historical sample.
- High turnover leads to transaction costs that the Sharpe ratio fails to deduct.
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