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Down-Side Risk Metrics as Portfolio Diversification Strategies across the Global Financial Crisis

Author

Listed:
  • David E. Allen

    () (School of Mathematics and Statistics, the University of Sydney, and Center for Applied Financial Studies, University of South Australia, Adelaide, Australia)

  • Michael McAleer

    () (Department of Quantitative Finance National Tsing Hua University Taiwan and Econometric Institute Erasmus School of Economics Erasmus University Rotterdam and Tinbergen Institute The Netherlands and Department of Quantitative Economics, Complutense University of Madrid, Spain)

  • Robert J. Powell

    () (School of Business and Law, Edith Cowan University, Australia)

  • Abhay K. Singh

    () (School of Business and Law, Edith Cowan University, Australia)

Abstract

This paper features an analysis of the effectiveness of a range of portfolio diversification strategies, with a focus on down-side risk metrics, as a portfolio diversification strategy in a European market context. We apply these measures to a set of daily arithmetically-compounded returns, in U.S. dollar terms, on a set of ten market indices representing the major European markets for a nine-year period from the beginning of 2005 to the end of 2013. The sample period, which incorporates the periods of both the Global Financial Crisis (GFC) and the subsequent European Debt Crisis (EDC), is a challenging one for the application of portfolio investment strategies. The analysis is undertaken via the examination of multiple investment strategies and a variety of hold-out periods and backtests. We commence by using four two-year estimation periods and a subsequent one-year investment hold out period, to analyse a naive 1/N diversification strategy and to contrast its effectiveness with Markowitz mean variance analysis with positive weights. Markowitz optimisation is then compared to various down-side investment optimisation strategies. We begin by comparing Markowitz with CVaR, and then proceed to evaluate the relative effectiveness of Markowitz with various draw-down strategies, utilising a series of backtests. Our results suggest that none of the more sophisticated optimisation strategies appear to dominate naive diversification.

Suggested Citation

  • David E. Allen & Michael McAleer & Robert J. Powell & Abhay K. Singh, 2016. "Down-Side Risk Metrics as Portfolio Diversification Strategies across the Global Financial Crisis," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 9(2), pages 1-18, June.
  • Handle: RePEc:gam:jjrfmx:v:9:y:2016:i:2:p:6-:d:72448
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    References listed on IDEAS

    as
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    Cited by:

    1. David E. Allen & Michael McAleer & Abhay K. Singh, 2016. "A Multi-Criteria Portfolio Analysis of Hedge Fund Strategies," Documentos de Trabajo del ICAE 2017-03, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    2. repec:gam:jecnmx:v:5:y:2017:i:2:p:18-:d:97715 is not listed on IDEAS

    More about this item

    Keywords

    portfolio diversification; Markowitz analysis; downside risk; CVaR; draw-down;

    JEL classification:

    • C - Mathematical and Quantitative Methods
    • E - Macroeconomics and Monetary Economics
    • F2 - International Economics - - International Factor Movements and International Business
    • F3 - International Economics - - International Finance
    • G - Financial Economics

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