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The Maximum drawdown as a Risk Measure: the Role of Real Estate in the Optimal Portfolio

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  • Martin Hoesli
  • Hamelink Foort

Abstract

In this paper we investigate the role of real estate in a mixed-asset portfolio when the maximum drawdown (hereafter MaxDD), rather than standard deviation, is used as the measure of risk. The recent crash of equity markets around the world, and the consequences this has had on the balance between assets and liabilities for most pension funds, have lead to an increased interest in alternative measures of risk, both from a theoretical and a practical point of view. We argue that the MaxDD concept is one of the most natural measures of risk, much more so than measures such as Valueat- Risk (VAR) which have gained popularity in recent years. To assess the practical implications of the use of the MaxDD, we investigate optimal portfolios obtained under the MaxDD criterion for a Swiss institutional investor who is faced with legal constraints on the weights that can be allocated to the various asset categories. The asset classes considered are: Swiss and foreign equities, bonds, and indirect real estate, as well as Swiss direct real estate. We show that most portfolios optimized in Return/MaxDD space, rather than in Return/Standard Deviation space, yield a much lower MaxDD, while only a slightly higher standard deviation (for the same level of return). The reduction in MaxDD is highest for portfolios situated halfway on the efficient frontier, typically close to those held by pension funds.

Suggested Citation

  • Martin Hoesli & Hamelink Foort, 2003. "The Maximum drawdown as a Risk Measure: the Role of Real Estate in the Optimal Portfolio," ERES eres2003_172, European Real Estate Society (ERES).
  • Handle: RePEc:arz:wpaper:eres2003_172
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    File URL: https://eres.architexturez.net/doc/oai-eres-id-eres2003-172
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    Cited by:

    1. Mohammad Reza Tavakoli Baghdadabad & Paskalis Glabadanidis, 2013. "Average Drawdown Risk and Capital Asset Pricing," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 16(04), pages 1-21.
    2. Aleksandar Mijatovic & Martijn R. Pistorius, 2011. "On the drawdown of completely asymmetric Levy processes," Papers 1103.1460, arXiv.org, revised Sep 2012.

    More about this item

    JEL classification:

    • R3 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location

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