Maximum Drawdown and the Allocation to Real Estate

Foort Hamelink and Martin Hoesli
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Foort Hamelink: Lombard Odier Darier Hentsch, Vrije Universiteit and FAME

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: We investigate the role of real estate in a mixed-asset portfolio when the maximum drawdown (hereafter MaxDD), rather than the standard deviation, is used as the measure of risk. In particular, we analyse whether the discrepancy between the optimal allocation to real estate and the actual allocation by institutional investors is less when a Return/MaxDD framework is used. The empirical analysis is conducted from the perspective of a Swiss investor using international data for the period 1979-2002. We show that most portfolios optimised in Return/MaxDD space, rather than in Return/Standard Deviation space, yield a much lower MaxDD, while only a slightly higher standard deviation (for the same level of return). The reduction in MaxDD is highest for portfolios situated half-way on the efficient frontier, typically close to those held by pension funds. Also, the reported weights for real estate are much more in line with the actual weights to real estate by institutional investors.

Keywords: Maximum Drawdown; Downside Risk; Portfolio Diversification; Real Estate (search for similar items in EconPapers)
JEL-codes: G11 (search for similar items in EconPapers)
Date: 2003-11
New Economics Papers: this item is included in nep-fin and nep-ure
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Journal Article: Maximum drawdown and the allocation to real estate (2004)
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