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Drawdown: from practice to theory and back again


Goldberg, Lisa R; Mahmoud, Ola (2017). Drawdown: from practice to theory and back again. Mathematics and Financial Economics, 11(3):275-297.

Abstract

Maximum drawdown, the largest cumulative loss from peak to trough, is one of the most widely used indicators of risk in the fund management industry, but one of the least developed in the context of measures of risk. We formalize drawdown risk as Conditional Expected Drawdown (CED), which is the tail mean of maximum drawdown distributions. We show that CED is a degree one positive homogenous risk measure, so that it can be linearly attributed to factors; and convex, so that it can be used in quantitative optimization. We empirically explore the differences in risk attributions based on CED, Expected Shortfall (ES) and volatility. An important feature of CED is its sensitivity to serial correlation. In an empirical study that fits AR(1) models to US Equity and US Bonds, we find substantially higher correlation between the autoregressive parameter and CED than with ES or with volatility.

Abstract

Maximum drawdown, the largest cumulative loss from peak to trough, is one of the most widely used indicators of risk in the fund management industry, but one of the least developed in the context of measures of risk. We formalize drawdown risk as Conditional Expected Drawdown (CED), which is the tail mean of maximum drawdown distributions. We show that CED is a degree one positive homogenous risk measure, so that it can be linearly attributed to factors; and convex, so that it can be used in quantitative optimization. We empirically explore the differences in risk attributions based on CED, Expected Shortfall (ES) and volatility. An important feature of CED is its sensitivity to serial correlation. In an empirical study that fits AR(1) models to US Equity and US Bonds, we find substantially higher correlation between the autoregressive parameter and CED than with ES or with volatility.

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27 citations in Web of Science®
29 citations in Scopus®
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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Physical Sciences > Statistics and Probability
Social Sciences & Humanities > Finance
Social Sciences & Humanities > Statistics, Probability and Uncertainty
Scope:Discipline-based scholarship (basic research)
Language:English
Date:2017
Deposited On:14 Feb 2019 13:54
Last Modified:20 Jul 2024 01:38
Publisher:Springer
ISSN:1862-9679
OA Status:Closed
Publisher DOI:https://doi.org/10.1007/s11579-016-0181-9
Other Identification Number:merlin-id:17370
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