On the (Ab)Use of Omega?

73 Pages Posted: 3 Feb 2015 Last revised: 12 Jul 2016

See all articles by Massimiliano Caporin

Massimiliano Caporin

University of Padova - Department of Statistical Sciences

Michele Costola

Leibniz Institute for Financial Research SAFE

Gregory Mathieu Jannin

University Paris-1 Panthéon-Sorbonne; ABN AMRO ADVISORS - QCG

Bertrand B. Maillet

EMLyon Business School (Paris Campus)

Date Written: July 11, 2016


Several recent finance articles employ the Omega measure, proposed by Keating and Shadwick (2002) - defined as a ratio of potential gains out of possible losses - for gauging the performance of funds or active strategies (e.g. Eling and Schuhmacher, 2007; Farinelli and Tibiletti, 2008; Annaert et al., 2009; Bertrand and Prigent, 2011; Zieling et al., 2014; Kapsos et al., 2014; Hamidi et al., 2014), in substitution of the traditional Sharpe ratio (1966), with the arguments that return distributions are not Gaussian and volatility is not, always, the relevant risk metric. Other authors also use the same criterion for optimizing (non-linear) portfolios with important downside risk. However, we wonder in this article about the relevance of such approaches. First, we show through a basic illustration that the Omega ratio is inconsistent with the Strict Inferior Second-order Stochastic Dominance criterion. Furthermore, we observe that the trade-off between return and risk, corresponding to the Omega measure, may be essentially influenced by the mean return. Next, we illustrate in static and dynamic frameworks that Omega-based optimal portfolios can be associated with traditional optimization paradigms depending on the chosen threshold used in the computation of Omega. Finally, we present some robustness checks on long-only asset and hedge fund databases that all confirm our general results.

Keywords: Performance Measure, Omega, Return Distribution, Risk, Stochastic Dominance

JEL Classification: C10, C11, G12

Suggested Citation

Caporin, Massimiliano and Costola, Michele and Jannin, Gregory Mathieu and Maillet, Bertrand B., On the (Ab)Use of Omega? (July 11, 2016). University Ca' Foscari of Venice, Dept. of Economics Working Paper Series No. 02/WP/2015. Available at SSRN: https://ssrn.com/abstract=2559216 or http://dx.doi.org/10.2139/ssrn.2559216

Massimiliano Caporin

University of Padova - Department of Statistical Sciences ( email )

Via Battisti, 241
Padova, 35121

Michele Costola

Leibniz Institute for Financial Research SAFE ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323

Gregory Mathieu Jannin

University Paris-1 Panthéon-Sorbonne ( email )

Department of Management Sciences (PRISM-Sorbonne)
17 rue de la Sorbonne
Paris, 75005

HOME PAGE: http://www.univ-paris1.gregoryjannin.com


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

Bertrand B. Maillet (Contact Author)

EMLyon Business School (Paris Campus) ( email )

23 Avenue Guy de Collongue
Ecully, 69132

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