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Downside risk in multiperiod tracking error models

  • Diana Barro

    ()

    (Department of Economics, University Of Venice Cà Foscari)

  • Elio Canestrelli

    (Department of Economics, University Of Venice Cà Foscari)

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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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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  1. 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.
  2. Diana Barro & Elio Canestrelli, 2005. "Tracking Error: a multistage portfolio model," GE, Growth, Math methods 0510012, EconWPA.
  3. Hiroshi Konno & Hiroaki Yamazaki, 1991. "Mean-Absolute Deviation Portfolio Optimization Model and Its Applications to Tokyo Stock Market," Management Science, INFORMS, vol. 37(5), pages 519-531, May.
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  6. 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.
  7. 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.
  8. 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.
  9. 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.
  10. Brennan, M.J. & Solanki, R., 1981. "Optimal Portfolio Insurance," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(03), pages 279-300, September.
  11. Basak, Suleyman, 1995. "A General Equilibrium Model of Portfolio Insurance," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 1059-90.
  12. 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.
  13. Gordon J. Alexander & Alexandre M. Baptista, 2004. "A Comparison of VaR and CVaR Constraints on Portfolio Selection with the Mean-Variance Model," Management Science, INFORMS, vol. 50(9), pages 1261-1273, September.
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