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Downside risk in multiperiod tracking error models

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  • Diana Barro

    ()
    (Department of Economics, University Of Venice Cà Foscari)

  • Elio Canestrelli

    (Department of Economics, University Of Venice Cà Foscari)

Abstract

The recent crisis made it evident that replicating the performance of a benchmark is not a sufficient goal to meet the expectations of usually risk-averse investors. The manager should also consider that the investor are seeking for a downside protection when the benchmark performs poorly and thus they should integrate a form of downside risk control. We propose a multiperiod double tracking error portfolio model which combines these two goals and provide enough flexibility. In particular, the control of the downside risk is carried out through the presence of a floor benchmark with respect to which we can accept different levels of shortfall. The choice of a proper measure for downside risk leads to different problem formulations and investment strategies which can reflect different attitudes towards risk. The proposed model is tested through a set of out-of-sample rolling simulation in different market conditions.

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Bibliographic Info

Paper provided by Department of Economics, University of Venice "Ca' Foscari" in its series Working Papers with number 2012_17.

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Length: 23
Date of creation: 2012
Date of revision:
Handle: RePEc:ven:wpaper:2012_17

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Keywords: Tracking error; Downside risk; Dynamic portfolio; Stochastic programming;

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  1. Basak, Suleyman, 1995. "A General Equilibrium Model of Portfolio Insurance," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1059-90.
  2. Consiglio, Andrea & Saunders, David & Zenios, Stavros A., 2006. "Asset and liability management for insurance products with minimum guarantees: The UK case," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 645-667, February.
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  4. El Karoui, Nicole & Jeanblanc, Monique & Lacoste, Vincent, 2005. "Optimal portfolio management with American capital guarantee," Journal of Economic Dynamics and Control, Elsevier, vol. 29(3), pages 449-468, March.
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  7. Griselda Deelstra & Martino Grasselli & Pierre-François Koehl, 2003. "Optimal investment strategies in the presence of a minimum guarantee," ULB Institutional Repository 2013/7598, ULB -- Universite Libre de Bruxelles.
  8. Deelstra, Griselda & Grasselli, Martino & Koehl, Pierre-Francois, 2003. "Optimal investment strategies in the presence of a minimum guarantee," Insurance: Mathematics and Economics, Elsevier, vol. 33(1), pages 189-207, August.
  9. Diana Barro & Elio Canestrelli, 2005. "Tracking Error: a multistage portfolio model," GE, Growth, Math methods 0510012, EconWPA.
  10. Alexander, Gordon J. & Baptista, Alexandre M., 2006. "Portfolio selection with a drawdown constraint," Journal of Banking & Finance, Elsevier, vol. 30(11), pages 3171-3189, November.
  11. Rudolf, Markus & Wolter, Hans-Jurgen & Zimmermann, Heinz, 1999. "A linear model for tracking error minimization," Journal of Banking & Finance, Elsevier, vol. 23(1), pages 85-103, January.
  12. Alexei Chekhlov & Stanislav Uryasev & Michael Zabarankin, 2005. "Drawdown Measure In Portfolio Optimization," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(01), pages 13-58.
  13. Gaivoronski, Alexei A. & Krylov, Sergiy & van der Wijst, Nico, 2005. "Optimal portfolio selection and dynamic benchmark tracking," European Journal of Operational Research, Elsevier, vol. 163(1), pages 115-131, May.
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