Abstract

http://ssrn.com/abstract=1091590
 
 

References (28)



 
 

Citations (2)



 


 



The Effect of Shortfall as a Risk Measure for Portfolios with Hedge Funds


Andre Lucas


VU University Amsterdam - Faculty of Economics and Business; Tinbergen Institute

Arjen Siegmann


VU University Amsterdam - Faculty of Economics and Business Administration

2007-05

Journal of Business Finance & Accounting, Vol. 35, Issue 1-2, pp. 200-226, January/March 2008

Abstract:     
Current research suggests that the large downside risk in hedge fund returns disqualifies the variance as an appropriate risk measure. For example, one can easily construct portfolios with nonlinear pay-offs that have both a high Sharpe ratio and a high downside risk. This paper examines the consequences of shortfall-based risk measures in the context of portfolio optimization. In contrast to popular belief, we show that negative skewness for optimal mean-shortfall portfolios can be much greater than for mean-variance portfolios. Using empirical hedge fund return data we show that the optimal mean-shortfall portfolio substantially reduces the probability of small shortfalls at the expense of an increased extreme crash probability. We explain this by proving analytically under what conditions short-put payoffs are optimal for a mean-shortfall investor. Finally, we show that quadratic shortfall or semi-variance is less prone to these problems. This suggests that the precise choice of the downside risk measure is highly relevant for optimal portfolio construction under loss averse preferences.

Number of Pages in PDF File: 27

Accepted Paper Series





Date posted: February 15, 2008  

Suggested Citation

Lucas, Andre and Siegmann, Arjen, The Effect of Shortfall as a Risk Measure for Portfolios with Hedge Funds (2007-05). Journal of Business Finance & Accounting, Vol. 35, Issue 1-2, pp. 200-226, January/March 2008. Available at SSRN: http://ssrn.com/abstract=1091590 or http://dx.doi.org/10.1111/j.1468-5957.2007.02054.x

Contact Information

Andre Lucas (Contact Author)
VU University Amsterdam - Faculty of Economics and Business ( email )
De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands
+31 20 598 6039 (Phone)
+31 20 598 6020 (Fax)
HOME PAGE: http://www.feweb.vu.nl
Tinbergen Institute
Roetersstraat 31
Amsterdam, 1018 WB
Netherlands
HOME PAGE: http://www.tinbergen.nl
Arjen Siegmann
VU University Amsterdam - Faculty of Economics and Business Administration ( email )
De Boelelaan 1105
Dept. of Finance
Amsterdam, 1081 HV
Netherlands
HOME PAGE: http://staff.feweb.vu.nl/asiegmann
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References:  28
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