Moment-Free Sharpe Ratio Estimation from Total Drawdown Durations
15 Pages Posted: 8 May 2015 Last revised: 27 Oct 2015
Date Written: July 10, 2015
The total duration of drawdowns is shown to be an efficient and robust estimator of Sharpe ratios. Its properties are distribution-dependent: the expected total drawdown duration is smaller for heavy-tailed returns than for Gaussian ones. As a consequence, in leptokurtic market conditions, the new estimator yields smaller Sharpe ratios than moment-based estimators, which implies that the standard estimator overestimates the information content of prices when the return distribution has heavy tails. Accordingly, using the standard estimator for taking trend-following decisions enhances large price fluctuations.
Keywords: Sharpe ratio, drawdown total duration, robust estimation, efficiency, price records
JEL Classification: C13, C14
Suggested Citation: Suggested Citation