The Maximum Drawdown as a Risk Measure: The Role of Real Estate in the Optimal Portfolio Revisited

FAME Research Paper No. 87

41 Pages Posted: 22 Jul 2003

See all articles by Foort Hamelink

Foort Hamelink

Lombard Odier Asset Management (SA); VU University Amsterdam

Martin Hoesli

University of Geneva - Geneva School of Economics and Management (GSEM); Swiss Finance Institute; University of Aberdeen - Business School

Date Written: June 2003

Abstract

We investigate the role of real estate in a mixed-asset portfolio when the maximum drawdown (hereafter MaxDD), rather than the standard deviation, is used as the measure of risk. We argue that the MaxDD concept is one of the most natural measures of risk, and that such a framework can help reconcile the optimal allocations to real estate and the effective allocations by institutional investors. The empirical analysis is conducted from the perspective of Swiss pension funds who are faced with legal constraints on the weights that can be allocated to the various asset categories and pertains to the period 1979-2002. We show that most portfolios optimized in Return/MaxDD space, rather than in Return/Standard Deviation space, yield a much lower MaxDD, while only a slightly higher standard deviation (for the same level of return). The reduction in MaxDD is highest for portfolios situated half-way on the efficient frontier, typically close to those held by pension funds. Also, the reported weights for real estate are much more in line with the actual weights to real estate by institutional investors.

JEL Classification: G11

Suggested Citation

Hamelink, Foort and Hoesli, Martin Edward Ralph, The Maximum Drawdown as a Risk Measure: The Role of Real Estate in the Optimal Portfolio Revisited (June 2003). FAME Research Paper No. 87, Available at SSRN: https://ssrn.com/abstract=423181 or http://dx.doi.org/10.2139/ssrn.423181

Foort Hamelink (Contact Author)

Lombard Odier Asset Management (SA) ( email )

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Switzerland

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

VU University Amsterdam ( email )

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Netherlands

Martin Edward Ralph Hoesli

University of Geneva - Geneva School of Economics and Management (GSEM) ( email )

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Geneva 4, Geneva 1211
Switzerland
+41 22 379 8122 (Phone)
+41 22 379 8104 (Fax)

Swiss Finance Institute

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University of Aberdeen - Business School ( email )

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United Kingdom
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+41 22 379 8104 (Fax)

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