Maximum Drawdown and Risk Tolerances

Mohammad Reza Tavakoli Baghdadabad ()
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Mohammad Reza Tavakoli Baghdadabad: Department of Management, Islamic Azad University, Science and Research Branch, Tehran, Iran

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2015, vol. 18, issue 01, 1-27

Abstract: Due to the numerous studies of asymmetric portfolio returns, asymmetric risk measures have widely been used in risk management with extensive uses on the methodology ofn-degree lower partial moment (LPM). Unlike the initial studies, we use the risk measure ofn-degree maximum drawdown, which is a special case ofn-degree LPM, to investigate the reduction impacts ofn-degree maximum drawdown risk on risk tolerances generated by management styles from US equity-based mutual funds. We found that skewness does not impose any significant problems on the model ofn-degree maximum drawdown. Thus, the tolerance effect of maximum drawdown risk in then-degree M-DRM models is a decrease in fund returns. Then-degree CM-DRM optimization model decreased investors' risk more than two conventional models. Thus, the M-DRM can be accommodated with risk-averse investors' approach. The efficient set of mean-variance choices from the investment opportunity set, as described by Markowitz, shows that then-degree CM-DRM algorithms create this set with lower risk than other algorithms. It implies that the mean-variance opportunity set generated by then-degree CM-DRM creates lower risk for a given return than covariance and CLPM.

Keywords: Drawdown risk measure; maximum drawdown risk measure; lower partial moment; downside risk; investors' perception; risk tolerance (search for similar items in EconPapers)
JEL-codes: G1 G2 G3 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1142/S0219091515500034

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