Omega ratio explained: risk-adjusted performance evaluation (Excel)

How to take into account the interaction between the upside and the downside of the portfolio as well as the whole shape of the portfolio return distribution? The answer is often the Omega ratio - an intuitive and simple tool for risk-adjusted performance evaluation developed by Keating and Shadwick in 2002 and popular with investment practitioners. Today we will learn how to apply and interpret the Omega ratio in Excel using a portfolio of five stocks.
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[@NEDLeducation]

You can find the spreadsheets for this video and some additional materials here: drive.google.com/drive/folders/1sP40IW0p0w5IETCgo464uhDFfdyR6rh7 Please consider supporting NEDL on Patreon: www.patreon.com/NEDLeducation

[@marcus.guitarist]

This guy's spreadsheet skills are over 9000.

[@TonyStark-ir8ke]

Happy to give you your 100th like, very nice video, with clear explanation! Cheers

[@kanzzon]

Wow, this video is a treasure!

[@eduardo.garcia]

Amazing video, clear explanation theoretically and practically. Thanks a lot 😁👍🏽

[@NEDLeducation]

Hi Eduardo, and glad you liked the video, stay tuned for more content on portfolio management!

[@supritinanda8732]

Thank You for all your videos. Your channel is one of the best I have found for finance. Thank You again. Very Helpful.

Would you mind sharing the other best channels as well?

[@francoguevara5806]

Thanks

[@Jevin02]

Loved the video, very informative. Just a small question, how do you import all that data onto your excel spreadsheet? I'd like to calculate the omega ratio's for some crypto's but i don't know where and how to get all that data.

[@aseemsharma1095]

When it says that numerator is sum of weighted average of returns above theta, is it the same as CAGR - expected returns?

[@vishka07]

Hi, can p-value be apply to Omega Ratio? Thanks, love your videos.

[@NEDLeducation]

Hi, and thanks for the question! There is unfortunately no natural way as far as I know to model the omega ratio distribution, but you can always apply Monte-Carlo simulation to see whether your omega ratio for your strategy is above the certain threshold (like 90%, 95%, or 99% for conventional confidence intervals). What you can do is for example sample 1,000 random portfolios, with each weight initially coded as a random number between 0 and 1 (RAND() in Excel), and then normalise the weights buy dividing each by the sum of random numbers (so they sum up to one). Then you can measure the Omega ratio of these portfolios and see whether the Omega ratio of your strategy does outperform 90%, 95%, or 99% of the random portfolios.

[@diegoalonsosanchezvicua7127]

Hi! I have a question. If a have a range of 10 portfolios with different omega ratios, which one I should choose? The one with the lowest or the one with the highest omega ratio?

[@NEDLeducation]

Hi Diego, and thanks for the question! Higher Omega ratio values show portfolios with better risk adjusted returns, so select these.

[@vladk9152]

What are the differences in portfolios that are optimized for sharpe ratio, sortino ratio and omega ratio? And where does the omega ratio stay in the efficient frontier?

[@NEDLeducation]

Hi Jorge, and thanks for the excellent question! Theoretically, omega-optimised portfolios should be closer to the Sortino-optimised portfolio. Both would lie within the efficient frontier as they use a different measure of risk to the conventional portfolio theory that gives birth to Sharpe ratio. You can think of a Sortino-optimised portfolio as a tangency portfolio for a frontier where the risk measure is downside risk (semideviation) and the intercept of the tangent is the minimally acceptable return, and of an omega-optimised portfolio as a tangency portfolio for a frontier where the intercept of the tangent is the target return and the measure of risk is the average underperformance below the target. Hope this helps!

[@hijaali]

great video. What optimiser would you use if you want to short positions?

[@NEDLeducation]

Hi, and glad you liked the video! If you would like to enable short positions, you can still use the same algorithm, just untick the "unconstrained variables non-negative" box.

[@hijaali]

@@NEDLeducation thanks. For some target returns it doesn't converge? Also if solver tells you to go say -200% and -100% and +300% for stock 1, stock2 and stock 3 respectively does that assume you get cashflow from going short on stock 1 and stock 2 to pay for going long on stock 3?

[@honza8939]

Can you explain to me why the Omega ratio in the formula is: plus 1 and the Sharp ratio is not? If I added + 1 to the Sharpe ratio would the interpretation of this ratio remain the same? Thanks for the cool video.

[@NEDLeducation]

Hi Honza, the +1 comes from the simplification of the original integral into the form that is applied in this video.

[@trikuncoroprasetyohutomo8958]

I want to ask where the number 252 comes from? Anyway, your video really helped me in doing my thesis. Thankyou.

[@NEDLeducation]

Hi, and thanks for the question! 252 is the typical number of trading days in a year so it features extensively in annualised formulae.

[@Shidee1t]

Hi I need some help in my thesis

[@Shidee1t]

Pls help

[@Shidee1t]

I will pay also

[@mohammadtalib2041]

why have you used 1/252 and not 1/2516 in the power to calculate the target daily

[@raydespoir]

@4:18 - Why don't you use the AVERAGE function in Excel instead of PRODUCT?

[@davidring5071]

wow

[@Auditorsha]

Снимите видео про разложение холецкого и как оно используется в управлении рискам пожалуйста

[@NEDLeducation]

Спасибо за предложение, видео о разложение Холецкого в планах!