Dynamic Allocation Strategies for Absolute and Relative Loss Control
24 Pages Posted: 8 Mar 2014 Last revised: 12 Dec 2014
Date Written: July 22, 2014
The maximum drawdown control strategy dynamically allocates wealth between cash and a risky portfolio, keeping losses below a chosen pre-defined level. This paper introduces variations of the strategy, namely the excess drawdown and the relative drawdown control strategies. The excess drawdown control is a more flexible strategy that can cope with common (re)allocation restrictions such as lock-up periods, cash bans or liquidity constraints through an implementation with a hedging overlay. The relative drawdown control strategy is adapted to contexts in which investors seek to limit benchmark underperformance instead of absolute losses. A formal proof that the loss-control objectives introduced can be insured using dynamic allocation is provided and the potential benefits and implementation aspects of the strategies are illustrated with examples.
Keywords: Risk Management, Portfolio Insurance, Hedging Overlay, Loss Aversion, Benchmarks
JEL Classification: G11, G110
Suggested Citation: Suggested Citation