DEFINITION of K-Ratio
K-ratio is a return vs. risk ratio. It tests the consistency of an equity return over time.
WHAT IT IS IN ESSENCE
The data for the ratio is derived from the value-added monthly index (VAMI). VAMI tracks the progress of a $1,000 initial investment in the security being analyzed. It is calculated as K-ratio examines the consistency of an equity return over time.
If you do some research into the K-Ratio you will be able to better compare systems and increase your knowledge about this useful measure of system performance.
Lars Kestner first introduced this measure in an article in TASC in 1996. He wanted to know how smooth the equity curve of a system was, and here is where he claimed “I have developed a new method of evaluating performance that is more robust than current popular techniques. This method, which maintains the idea of measuring reward as compared with risk, utilizes more advanced statistical techniques to quantify performance. Rather than simply looking at returns independently, consistency of results through time will be the focal point of this new performance method. ”
But the problem is the K-Ratio has had its formula changed twice since then, 2003 and 2013.
K-ratio is calculated as:
K – Ratio = Slope of Log VAMI Regression Line Square Root of the Number of Observations Per Year
HOW TO USE
It is recognized as a good tool to measure the performance of equity. It takes into account the return trend, not the point in time snapshots. The K-ratio allows for comparison of cumulative returns for different equities returns. It is created to be part of other measures of performance. It isn’t created to be a unique measure.
K-ratios can also be calculated for bonds. It differs across asset classes, within asset classes and by time period.