Portfolio Construction and Performance Measurement when Returns are Non-Normal

Karen Benson, Philip Gray, Egon Kalotay and Judy Qiu
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Karen Benson: UQ Business School, The University of Queensland, St Lucia, QLD 4072.
Philip Gray: UQ Business School, The University of Queensland, St Lucia, QLD 4072.
Egon Kalotay: Department of Accounting and Finance, Macquarie University.
Judy Qiu: UQ Business School, The University of Queensland, St Lucia, QLD 4072.

Australian Journal of Management, 2008, vol. 32, issue 3, 445-461

Abstract: The foundation of popular approaches to portfolio construction and performance measurement lies in the mean-variance framework of Markowitz (1952, 1959). However, the suitability of such approaches in practice is questionable in light of considerable evidence of non-normalities in returns. This paper explores the potential usefulness of a non-parametric approach to portfolio construction and performance measurement recently proposed by Stutzer (2000). The Portfolio Performance Index (PPI) is based on the notion that investors associate risk with the failure to achieve a target return. Stutzer proposes that portfolio construction and performance measurement be approached by calculating the decay rate in the probability that a given portfolio will underperform its designated benchmark. By comparing the PPI and Sharpe ratio metrics, this paper presents preliminary evidence of the economic significance of non-normalities in Australian equity returns, and documents the impact of such on portfolio construction and performance evaluation practice.

Keywords: PERFORMANCE MEASUREMENT; PORTFOLIO CONSTRUCTION; DOWNSIDE RISK; SHARPE RATIO; INFORMATION RATIO (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:sae:ausman:v:32:y:2008:i:3:p:445-461

DOI: 10.1177/031289620803200304

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