Constructing a 20-Day Sharpe Ratio Factor for Stocks

Summary

This note describes a stock risk factor based on the Sharpe ratio over a 20-day period. It defines the measure as annualized stock return minus a risk-free rate, divided by the stock return standard deviation. The stated risk-free rate is 0.04. The factor is refreshed by 9:00 on the next trading day and, by default, uses market-cap weighting.

The documented processing pipeline applies median-based outlier treatment, neutralizes for industry and log market capitalization, and then standardizes with a z-score. The response points readers to an implementation using the Empyrical library’s Sharpe calculation, while noting that calculation details may be adjusted. The note does not provide code, spell out the return annualization or volatility estimation, or report tests of predictive performance. Those choices would need to be checked before comparing implementations or using the factor in a strategy.

Key ideas

• The factor divides annualized stock return less a stated 0.04 risk-free rate by return volatility.
• The factor is described as a 20-day measure refreshed before the next trading day.
• Its default weighting is based on market capitalization.
• The processing steps are outlier treatment, industry and log market-cap neutralization, and z-score standardization.
• The response references an Empyrical-based calculation but does not include its implementation details.

Tags

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.