A review on drawdown risk measures and their implications for risk management

Abstract

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.

A Rational Risk Policy? Why Path Dependence Matters

“…While the Kelly criterion has many merits as an investment paradigm, one of the major downsides related to this "optimal risk-taking" concept is that it can lead to significant drawdowns [8,16]. An overview of the path-dependent drawdown measures can be found in [17]. The most intuitive approach looks at the maximum loss that a risk taker could have realized versus the high watermark in a specified investment horizon.…”