As highlighted by the recent market turmoil following COVID‐19, markets can experience significant retracements or drawdowns. While these recent market moves have definitely been large, significant drawdowns have been around since the start of financial markets. Various risk metrics such as Value at Risk and volatility are used to describe risk. The intuitive drawdown risk measure, which is often used in practice alongside the above metrics, is receiving more and more academic attention. In this article we provide a systematic review of the literature on the drawdown risk measures. We describe two different methodologies for calculating drawdowns and analyze drawdown based risk measures used in risk management, portfolio construction and optimization. Finally we discuss the statistical properties related to drawdowns. Based on the research done so far, we identify several areas for further research.

The Kelly criterion determines optimal bet sizes that maximize long-term growth. While growth is definitely an important consideration, the focus on growth alone can lead to significant drawdowns, leading to psychological discomfort for a risk-taker. Path-dependent risk measures, such as drawdown risk, provide a means to assess the risk of significant portfolio retracements. In this paper, we provide a flexible framework for assessing path dependent risk for a trading or investment operation. Given a certain set of profitable trading characteristics, a risk-taker who maximizes expected growth can still be faced with significant drawdowns to the point where a strategy becomes unsustainable. We demonstrate, through a series of experiments, the importance of path dependent risks in the case of outcomes subject to various return distributions. Based on Monte Carlo simulation, we analyze the medium-term behavior of different cumulative return paths and study the impact of different return outcome distributions. We show that in the case of heavier tailed outcomes, extra care is needed, and optimal might not be so optimal in the end.