Sufficient conditions for expected utility to imply drawdown-based performance rankings
The least restrictive sufficient condition for expected utility to imply Sharpe ratio rankings is the location and scale (LS) property (see [Sinn, 1983] and [Meyer, 1987]). The normal, the extreme value, and many other distributions commonly used in finance satisfy this property. We argue that the LS property is also sufficient for expected utility to imply drawdown-based performance measure rankings, because for investment funds satisfying the LS condition, the Sharpe ratio and drawdown-based performance measures result in identical rankings. Hence, the same conditions that provide an expected utility foundation for the Sharpe ratio also provide a foundation for drawdown-based performance measures. We conclude that from a decision-theoretic perspective, drawdown-based performance measures are as good as the Sharpe ratio.
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