Sortino Ratio calculation

Question

I've been using an Excel template to calculate the Sortino ratio for my automated trading strategies. http://investexcel.net/calculate-the-sortino-ratio-with-excel

Basically I input my monthly returns in the return column. That's 12 months of returns for each year from 2006 to 2014.

However, for one of the strategies, let's call it strat A, it had one exceptional year, which had no negative monthly returns. So when the template tries to calculate the Sortino ratio by dividing the returns by the downside risk etc it can't do the calculation because there was no downside risk. So it's dividing by 0 which messes up the calculation.

So I'm wondering what to do in such a scenario?

Answer 1

Firstly, I suggest you to use more recognized source to study and compute quantitative finance model or indicators; in such case, for instance, you could take as example the following paper as reference.

Precisely there, the authors describe some common errors that one can do in computing the Sortino ratio; although surely you did not do any of them, anyway it could be a good source.

As regards your question, the fact that you rightly get an error is mainly due to the way you set the target return; I suggest you to replace that value with average (median, mode, ...) return in the data sample or the benchmark index return and try to solve the issue in this way; of course, you should replace the target return with for all years.