What does the Deflated Sharpe Ratio (DSR) intend to measure?

The Deflated Sharpe Ratio (DSR) is specifically designed to measure risk-adjusted returns while accounting for the potential biases introduced by multiple testing. When evaluating the performance of investment strategies or portfolios, it is common to conduct numerous tests to identify the most favorable outcomes. This can create a misleading impression of performance due to the increased likelihood of false positives, known as multiple comparison problems.

The DSR addresses this issue by adjusting the traditional Sharpe Ratio, which merely assesses the excess return per unit of risk without considering the number of tests being conducted. By incorporating a deflation factor, the DSR provides a more reliable and conservative estimate of a strategy's true performance, ultimately helping investors to distinguish between genuine alpha and statistical anomalies caused by extensive testing.

The other options do not directly relate to what the DSR measures. Options concerning annualized return, market volatility, or standard deviation do not incorporate the critical adjustment for multiple testing that the DSR specifically aims to address. This makes the DSR a valuable tool in performance evaluation for those engaged in strategy development and backtesting.