Filtering the results through various drawdown variations reveals that some are better than others in identifying skill. Which measure of drawdown excels? In search of an answer, the authors simulate portfolios that select stocks from the MSCI World Index, allowing some portfolios to exhibit skillful management. “ByĬhoosing a set of weights, new drawdown measures can be developed and tailoredįor example, the paper considers several variations, including the average drawdown for a sample period, a linearly weighed drawdown, an average squared drawdown, and a trend weighted drawdown. Its main idea is to attach weights to different elements” of drawdown. They explain, is that “almost all drawdown measures can be subsumed under aĬommon framework, which we refer to as the weighted drawdown (wDD) framework because Point out, there are more ambitious ways to evaluate drawdown. Quantitative Investment Portfolio Analytics In R:Īn Introduction To R For Modeling Portfolio Risk and Return In turn, the deepest peak-to-trough decline can be compared with the equivalent for other markets to assess relative risk profiles. But the question is how to quantify the data? One could start with looking at the maximum drawdown, which in the chart above is a bit more than -55%. How the US stock market’s drawdown history stacks up since 2005 via the S&PĪs a simple, intuitive measure of risk, reviewing drawdown in this way has obvious appeal. Is often described as a simple peak-to-trough calculation. That there’s more than one measure of drawdown may be surprising. In conclusion, our study shows that the choice of an adequate drawdown measure is vital to the assessment of investments because different measures emphasize different aspects of risk. However, the ability to detect skill does not easily improve performance ratios where drawdown measures serve as the denominator. Our research also shows that all drawdown measures can (to some degree) discriminate between skillful and unskillful portfolio managers, but differ in terms of accuracy. They go on to advise in the study’s abstract:Ĭonceptual differences between drawdown measures translate into different rankings of portfolios, which we document in a simulation study. “Over the years, a diverse range of drawdown measures has evolved to guide asset management,” advise the authors of “Drawdown Measures: Are They All the Same?”, a recent working paper by Olaf Korn (University of Goettingen) and two co-authors. A new research paper reminds, however, that drawdown comes in several flavors and so investors need to think carefully when deploying this metric in the quest to identify genuinely skillful portfolio results. But any short list of robust metrics surely deserves to include drawdown, which offers a powerful combination of relevance and simplicity. Indeed, you can find dictionaries that wade through an ever-lengthening list of indicators. The possibilities for quantifying risk in portfolio analytics seem to be limited only by the imagination of researchers.
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