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Using Maximum Drawdowns to Capture Tail Risk

22 Pages Posted: 1 Mar 2013 Last revised: 4 Mar 2013

Wesley R. Gray

Alpha Architect; Drexel University - LeBow College of Business

Jack Vogel

Alpha Architect; Villanova University

Date Written: March 1, 2013

Abstract

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

Gray, Wesley R. and Vogel, Jack, Using Maximum Drawdowns to Capture Tail Risk (March 1, 2013). Available at SSRN: https://ssrn.com/abstract=2226689 or http://dx.doi.org/10.2139/ssrn.2226689

Wesley Gray (Contact Author)

Alpha Architect ( email )

213 Foxcroft Road
Broomall, PA 19008
United States
7732304727 (Phone)

HOME PAGE: http://www.alphaarchitect.com

Drexel University - LeBow College of Business ( email )

3141 Chestnut St
Philadelphia, PA 19104
United States

HOME PAGE: http://www.lebow.drexel.edu/corporate-services/corporate-and-executive-education/executive-faculty

Jack Vogel

Alpha Architect ( email )

213 Foxcroft Road
Broomall, PA 19008
United States
215-882-9983 (Phone)

HOME PAGE: http://alphaarchitect.com/

Villanova University ( email )

Villanova, PA 19085
United States

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