Downside Risk Management in Emerging Markets

Abstract

This article presents various techniques for downside risk control of an emerging markets equity index or long only fund. We evaluate different risk adjusted strategies applied to dynamic asset allocation between an emerging markets equity index and cash and at a later stage between an emerging markets equity index and a US bonds index. We demonstrate that it is possible to significantly reduce both volatility and maximum drawdown of an equity index without a notable decrease in returns by adjusting the allocation to the equity index according to risk levels measured either by volatility or tail risk using Extreme Value Theory. These techniques can be applied to the construction of risk control indices and funds which target a fixed level of volatility or tail risk through time.

Keywords: Emerging Markets, Tail Risk, Extreme Value Theory (EVT), Dynamic Asset allocation, Value at Risk (VaR), Expected Shortfall (ES), Conditional Value at Risk (CVaR), Maximum Drawdown, Volatility, Risk Management, Risk Control Index

JEL Classification: C10, G11, G15