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Beyond Sharpe ratio: Optimal asset allocation using different performance ratios

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  • Farinelli, Simone
  • Ferreira, Manuel
  • Rossello, Damiano
  • Thoeny, Markus
  • Tibiletti, Luisa

Abstract

As the assumption of normality in return distributions is relaxed, classic Sharpe ratio and its descendants become questionable tools for constructing optimal portfolios. In order to overcome the problem, asymmetrical parameter-dependent performance ratios have been recently proposed in the literature. The aim of this note is to develop an integrated decision aid system for asset allocation based on a toolkit of eleven performance ratios. A multi-period portfolio optimization up covering a fixed horizon is set up: at first, bootstrapping of asset return distributions is assessed to recover all ratios calculations; at second, optimal rebalanced-weights are achieved; at third, optimal final wealth is simulated for each ratios. Eventually, we make a robustness test on the best performance ratios. Empirical simulations confirm the weakness in forecasting of Sharpe ratio, whereas asymmetrical parameter-dependent ratios, such as the Generalized Rachev, Sortino-Satchell and Farinelli-Tibiletti ratios show satisfactorily robustness.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 32 (2008)
Issue (Month): 10 (October)
Pages: 2057-2063

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Handle: RePEc:eee:jbfina:v:32:y:2008:i:10:p:2057-2063

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Web page: http://www.elsevier.com/locate/jbf

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Keywords: Asset allocation Performance ratios One-sided measures Portfolio optimization;

References

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  1. Hiroshi Konno & Hiroaki Yamazaki, 1991. "Mean-Absolute Deviation Portfolio Optimization Model and Its Applications to Tokyo Stock Market," Management Science, INFORMS, vol. 37(5), pages 519-531, May.
  2. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  3. Farinelli, Simone & Tibiletti, Luisa, 2008. "Sharpe thinking in asset ranking with one-sided measures," European Journal of Operational Research, Elsevier, vol. 185(3), pages 1542-1547, March.
  4. Farinelli, Simone & Ferreira, Manuel & Rossello, Damiano & Thoeny, Markus & Tibiletti, Luisa, 2009. "Optimal asset allocation aid system: From "one-size" vs "tailor-made" performance ratio," European Journal of Operational Research, Elsevier, vol. 192(1), pages 209-215, January.
  5. Rockafellar, R. Tyrrell & Uryasev, Stanislav, 2002. "Conditional value-at-risk for general loss distributions," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1443-1471, July.
  6. Martin R. Young, 1998. "A Minimax Portfolio Selection Rule with Linear Programming Solution," Management Science, INFORMS, vol. 44(5), pages 673-683, May.
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Citations

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Cited by:
  1. Caporin, Massimiliano & Lisi, Francesco, 2011. "Comparing and selecting performance measures using rank correlations," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy, vol. 5(10), pages 1-34.
  2. Shin Kim, Young & Rachev, Svetlozar T. & Leonardo Bianchi, Michele & Fabozzi, Frank J., 2010. "Tempered stable and tempered infinitely divisible GARCH models," Journal of Banking & Finance, Elsevier, vol. 34(9), pages 2096-2109, September.
  3. Zakamouline, Valeri & Koekebakker, Steen, 2009. "Portfolio performance evaluation with generalized Sharpe ratios: Beyond the mean and variance," Journal of Banking & Finance, Elsevier, vol. 33(7), pages 1242-1254, July.
  4. Monica Billio & Massimiliano Caporin & Michele Costola, 2012. "Backward/forward optimal combination of performance measures for equity screening," Working Papers 2012_13, Department of Economics, University of Venice "Ca' Foscari".
  5. Glawischnig, Markus & Sommersguter-Reichmann, Margit, 2010. "Assessing the performance of alternative investments using non-parametric efficiency measurement approaches: Is it convincing?," Journal of Banking & Finance, Elsevier, vol. 34(2), pages 295-303, February.
  6. Homm, Ulrich & Pigorsch, Christian, 2012. "Beyond the Sharpe ratio: An application of the Aumann–Serrano index to performance measurement," Journal of Banking & Finance, Elsevier, vol. 36(8), pages 2274-2284.
  7. Dierkes, Maik & Erner, Carsten & Zeisberger, Stefan, 2010. "Investment horizon and the attractiveness of investment strategies: A behavioral approach," Journal of Banking & Finance, Elsevier, vol. 34(5), pages 1032-1046, May.
  8. Schuhmacher, Frank & Eling, Martin, 2012. "A decision-theoretic foundation for reward-to-risk performance measures," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 2077-2082.
  9. Barros Fernandes, José Luiz & Haas Ornelas, José Renato & Martínez Cusicanqui, Oscar Augusto, 2012. "Combining equilibrium, resampling, and analyst’s views in portfolio optimization," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1354-1361.
  10. Díaz, Antonio & González, María de la O & Navarro, Eliseo & Skinner, Frank S., 2009. "An evaluation of contingent immunization," Journal of Banking & Finance, Elsevier, vol. 33(10), pages 1874-1883, October.
  11. Chesney, Marc & Reshetar, Ganna & Karaman, Mustafa, 2011. "The impact of terrorism on financial markets: An empirical study," Journal of Banking & Finance, Elsevier, vol. 35(2), pages 253-267, February.
  12. Chen, Zhiping & Yang, Li, 2011. "Nonlinearly weighted convex risk measure and its application," Journal of Banking & Finance, Elsevier, vol. 35(7), pages 1777-1793, July.
  13. Kerstens, Kristiaan & Mounir, Amine & Van de Woestyne, Ignace, 2010. "Non-Parametric Frontier Estimates of Mutual Fund Performance Using C- and L-Moments: Some Specification Tests," Working Papers 2010/10, Hogeschool-Universiteit Brussel, Faculteit Economie en Management.
  14. Ronald J. Balvers & Dayong Huang, 2005. "Evaluation Of Linear Asset Pricing Models By Implied Portfolio Performance," Working Papers 05-06old2 Classification-, Department of Economics, West Virginia University.
  15. Darolles, Serge & Gourieroux, Christian, 2010. "Conditionally fitted Sharpe performance with an application to hedge fund rating," Journal of Banking & Finance, Elsevier, vol. 34(3), pages 578-593, March.
  16. Schuhmacher, Frank & Eling, Martin, 2011. "Sufficient conditions for expected utility to imply drawdown-based performance rankings," Journal of Banking & Finance, Elsevier, vol. 35(9), pages 2311-2318, September.

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