Omega Ratio

Article byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Omega Ratio Definition

The omega ratio is a weighted risk-return ratio for a given expected return level that helps us identify the chances of winning compared to losing (the higher, the better). It also considers the third and fourth momentum effect, i.e., skewness & Kurtosis, which gives this an immense usefulness compared to others.

For calculating the omega ratio, we require the cumulative excess return of the Asset. We need to calculate all the highs and lows cumulatively.

Key Takeaways

  • The omega ratio is a ratio that assesses the risk and return of an investment at a specific expected return level. It helps us determine the likelihood of winning versus losing, with a higher ratio indicating better chances of success.
  • To calculate the omega ratio, one needs to determine the cumulative excess return of the asset by calculating its highs and lows cumulatively.
  • Investors can measure their omega ratio using Treynor, Sharpe, Sortino, and Jensen Alpha methods. These ratios help select portfolios that align with their risk preferences and desired risk-return profile.

The Formula of Omega Ratio

Omega ratio formula

In simple form, the omega ratio formula can be understood as follows

Omega Ratio = ΣWinning – Benchmarking / ΣBenchmarking – Loosing

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Example of Omega Ratio

Standard DeviationStandard DeviationStandard deviation (SD) is a popular statistical tool represented by the Greek letter 'σ' to measure the variation or dispersion of a set of data values relative to its mean (average), thus interpreting the data's more = 4%, Mean Return = 6%

Return Earned in Past

PeriodReturn (X)Excess Return (X- x̄)

Omega Ratio formula = ∑ Winning – Benchmarking  / ∑ Benchmarking – Losing

= ∑ 15/ ∑ 15

Omega Ratio =1 

Types of Omega Ratio

The organization uses various measures to check its risk compared to the risk undertaken. As per the term structure theory of Fixed incomeFixed IncomeFixed Income refers to those investments that pay fixed interests and dividends to the investors until maturity. Government and corporate bonds are examples of fixed income more, people are willing to take the risk if they are compensated in the form of higher returns. The higher risk should support the higher return, but there should be a trade-off so that higher returns can be seen after adjusting on a risk-adjusted basis.

Any ratio used to check the performance should be used in conjunction with another ratio, not in isolation.

The following are different measures of the omega ratio.

Types of Omega Ratio

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The omega ratio is useful in choosing the portfolio per the investor’s desired profile. Some investors (Risk-averse people) want that they should at least earn the minimum rate of return that is the saving rate provided by the bank, or even more risk-averse people want that their capital should not be at risk. One can check their risk toleranceRisk ToleranceRisk tolerance is the investors' potential and willingness to bear the uncertainties associated with their investment portfolios. It is influenced by multiple individual constraints like the investor's age, income, investment objective, responsibilities and financial more level and risk appetite ability to choose a low or high omega ratio to align; they require a risk-return profile with the particular class.

Frequently Asked Questions (FAQs)

What is a good omega ratio?

e risk-adjusted performance is good if the ratio is greater than 1. It suggests the portfolio has a higher chance of achieving returns above the target level and a lower probability of incurring significant losses. In addition, a ratio of 1 indicates that the threshold value matches the average return on investment.

What is the difference between Omega and Sortino ratios?

The Omega ratio measures risk using the returns’ first-order lower partial moment (LPM) with the arithmetic means in the denominator. On the other hand, the Sortino ratio uses the second-order LPM with the quadratic mean in the denominator. In simple terms, the two ratios differ in the type of LPM used to measure risk.

What is the Omega ratio for mutual funds?

The omega ratio measures risk and return, similar to the Sharpe ratio. It is helpful for investors in evaluating the appeal of hedge funds, mutual funds, or individual securities.

Recommended Articles

This has been a guide to what is Omega Ratio & its definition. Here we discuss the formula to calculate the omega ratio, its example, benefits and limitations. You can learn more about budgeting from the following articles –

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