Drawdowns

19 Pages Posted: 24 Apr 2020 Last revised: 5 May 2020

See all articles by Otto Van Hemert

Otto Van Hemert

Man AHL

Mark Ganz

University of Cambridge - Downing College

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Sandy Rattray

Man Group plc

Eva Sanchez Martin

Man AHL

Darrel Yawitch

Man Group plc

Date Written: May 4, 2020

Abstract

Common risk metrics reported in academia include volatility, skewness, and factor exposures. The maximum drawdown statistic is rarely calculated, perhaps because it is path dependent and estimated with greater uncertainty. In practice, however, asset managers and fiduciaries routinely use the drawdown statistic for fund allocation and redemption decisions. To help such decisions, we begin by quantifying the probability of hitting a certain drawdown level, given various return distribution properties. Next, we show that drawdown-based rules can be particularly useful for improving investment performance over time by detecting managers that lose their ability to outperform. This can happen as a result of structural market changes, increased competition for the type of strategy employed, staff turnover or a fund accumulating too many assets. Finally, we show that drawdown-based rules can be used as a risk reduction technique, but this impacts both expected returns and risk.

Keywords: Trading strategies, alpha, outperformance, crowding, downside risk, skewness, hitting time, allocation, redemption, Type I error, Type II error, drawdown, Sharpe ratio, structural breaks, Corona crash, COVID-19 crash

JEL Classification: G11, G12, G17, G41, G23, C58

Suggested Citation

van Hemert, Otto and Ganz, Mark and Harvey, Campbell R. and Rattray, Sandy and Sanchez Martin, Eva and Yawitch, Darrel, Drawdowns (May 4, 2020). Available at SSRN: https://ssrn.com/abstract=3583864 or http://dx.doi.org/10.2139/ssrn.3583864

Otto Van Hemert

Man AHL ( email )

Riverbank House
2 Swan Lane
London, EC4R 3AD
United Kingdom

Mark Ganz

University of Cambridge - Downing College ( email )

Regent St
Cambridge, CB2 1DQ
United Kingdom

Campbell R. Harvey (Contact Author)

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)

HOME PAGE: http://www.duke.edu/~charvey

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Sandy Rattray

Man Group plc

Riverbank House
2 Swan Lane
London, EC4R 3AD
United Kingdom

Eva Sanchez Martin

Man AHL ( email )

Riverbank House
2 Swan Lane
London, EC4R 3AD
United Kingdom

Darrel Yawitch

Man Group plc ( email )

Riverbank House
2 Swan Lane
London, EC4R 3AD
United Kingdom

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