Dynamic Allocation Strategies for Absolute and Relative Loss Control

24 Pages Posted: 8 Mar 2014 Last revised: 12 Dec 2014

Daniel Mantilla-Garcia

Optimal Asset Management; EDHEC Risk Institute

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

Mantilla-Garcia, Daniel, Dynamic Allocation Strategies for Absolute and Relative Loss Control (July 22, 2014). Algorithmic Finance 2014, 3:30-4, pp. 209-231. Available at SSRN: https://ssrn.com/abstract=2405530 or http://dx.doi.org/10.2139/ssrn.2405530

Daniel Mantilla-Garcia (Contact Author)

Optimal Asset Management ( email )

171 Main St #298
Los Altos, CA 94022
United States

HOME PAGE: http://optimalam.com/

EDHEC Risk Institute ( email )


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