22 Pages Posted: 1 Mar 2013 Last revised: 4 Mar 2013
Date Written: March 1, 2013
We propose the use of maximum drawdown, the maximum peak to trough loss across a time series of compounded returns, as a simple method to capture an element of risk unnoticed by linear factor models: tail risk. Unlike other tail-risk metrics, maximum drawdown is intuitive and easy-to-calculate. We look at maximum drawdowns to assess tail risks associated with market neutral strategies identified in the academic literature. Our evidence suggests that academic anomalies are not anomalous: all strategies endure large drawdowns at some point in the time series. Many of these losses would trigger margin calls and investor withdrawals, forcing an investor to liquidate.
Keywords: empirical asset pricing, max drawdown, tail-risk, anomalies
JEL Classification: G12, G14
Suggested Citation: Suggested Citation
By Lu Zhang