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Effective return, risk aversion and drawdowns

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Author Info

  • Dacorogna, Michel M.
  • Gençay, Ramazan
  • Müller, Ulrich A.
  • Pictet, Olivier V.

Abstract

We derive two risk-adjusted performance measures for investors with risk averse preferences. Maximizing these measures is equivalent to maximizing the expected utility of an investor. The first measure, Xeff, is derived assuming a constant risk aversion while the second measure, Reff, is based on a stronger risk aversion to clustering of losses than of gains. The clustering of returns is captured through a multi-horizon framework. The empirical properties of Xeff, Reff are studied within the context of real-time trading models for foreign exchange rates and their properties are compared to those of more traditional measures like the annualized return, the Sharpe Ratio and the maximum drawdown. Our measures are shown to be more robust against clustering of losses and have the ability to fully characterize the dynamic behaviour of investment strategies.

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File URL: http://www.sciencedirect.com/science/article/pii/S0378437100004623
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Bibliographic Info

Article provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.

Volume (Year): 289 (2001)
Issue (Month): 1 ()
Pages: 229-248

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Handle: RePEc:eee:phsmap:v:289:y:2001:i:1:p:229-248

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Web page: http://www.journals.elsevier.com/physica-a-statistical-mechpplications/

Related research

Keywords: Performance measures; Sharpe ratio; Effective return; Drawdown;

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Cited by:
  1. Neely, Christopher J., 2003. "Risk-adjusted, ex ante, optimal technical trading rules in equity markets," International Review of Economics & Finance, Elsevier, vol. 12(1), pages 69-87.
  2. Heidorn, Thomas & Siragusano, Tindaro, 2004. "Die Anwendbarkeit der Behavioral Finance im Devisenmarkt," Frankfurt School - Working Paper Series 52, Frankfurt School of Finance and Management.
  3. 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.
  4. GIOT, Pierre & PETITJEAN, Mikael, 2006. "International stock return predictability: statistical evidence and economic significance," CORE Discussion Papers 2006088, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).

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