Calculate Kappa with Excel

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This Excel spreadsheet calculates Kappa, a generalized downside-risk adjusted
performance measure.

Introduced by Kaplan and Knowles (2004), Kappa unifies both the Sortino Ratio and
the Omega Ratio, and is defined by the following equation.

where is the mean return, is the threshold return, and LPMn is the n-th order
Lower Partial Moment.

The Sortino Ratio and Omega Ratio are simply variants of Kappa. The Sortino Ratio
is K2() and the Omega Ratio is K1() + 1.

Kaplan and Knowles (2004) conclude that while higher Kappa values are better, the
asbolute differences of Kappa between different investments are not easily
interpreted; accordingly, Kappa should only be used to rank investments. This
paper describes the theory and applications of Kappa in greater detail.

The Excel spreadsheet calculates Kappa from discrete return data (although you
could also calculate Kappa from the moments of a probability distribution). The
formula implemented in the Excel spreadsheet is relatively simple. If returns is a
named range containing the returns, tau is the threshold return desired by the
investor and n is the Kappa order, then Kappa is given by
{=AVERAGE(returns-tau)/AVERAGE( IF(returns < tau,1,0)*(tau-returns)^n)^(1/n)}

where the curly braces {} signify a matrix formula entered by Ctrl+Shift+Enter.