Maximum drawdown and the allocation to real estate

Abstract

The role of real estate in a mixed-asset portfolio is investigated when the maximum drawdown (hereafter MaxDD), rather than the standard deviation, is used as the measure of risk. In particular, it is analysed whether the discrepancy between the optimal allocation to real estate and the actual allocation by institutional investors is less when a Return/MaxDD framework is used. The empirical analysis is conducted from the perspective of a Swiss investor using international data for the period 1979-2002. It is shown that most portfolios optimized in Return/ MaxDD space, rather than in Return/Standard Deviation space, yield a much lower MaxDD, while usually only a slightly higher standard deviation (for the same level of return). Also, the reported weights for real estate are much more in line with the actual weights to real estate by institutional investors.

Forecasting Eurozone real-estate returns

“…For this purpose, we use the maximum-drawdown criterion. Hamelink and Hoesli (2004) apply the maximum-drawdown criterion to analyse real-estate investments. The maximum-drawdown criterion is defined as the loss an investor incurs when the simple trading rule requires an investment into the EPRA index at a local maximum of the index, and a disinvestment at the next local minimum of the index.…”

The effects of drawdown risk reduction on the US hedge funds

“…It is extended by practitioners who do not base their work on theoretical considerations. Most of the prior literature on the DRM are found in journals outside of finance (that is, Petroni and Rotundu, 2008), non-refereed finance journals (that is, Burke, 1994;Kestner, 1996) and finance journals geared to investment community (Pedersen and Alfvin, 2003;Hamelink and Hoesli, 2004;Magdon-Ismail et al, 2004;Sharma, 2004;Chekhlov et al, 2005;Ammann and Moerth, 2008;Cogneau and Hübner, 2009). However, this measure has been applied to finance literature recently as a new risk measure ( that is, Tashman and Frey, 2009;Tavakoli Baghdadabad et al, 2011, 2012.…”

“…It is the loss suffered when an asset is bought at a local maximum and sold at the next local minimum' (Hamelink and Hoesli, 2004) and/or the worst loss that a portfolio suffers over the holding period (Alexander and Baptista, 2006).…”

“…The M-DRM is the loss suffered when an asset is bought at a local maximum, and sold at the next local minimum (Hamelink and Hoesli, 2004). In the mean-drawdown behavior framework, investor's utility is U ¼ U(m P ,S P 2 ), where S P 2 denotes returns' drawdown risk on investor's portfolio.…”

Real estate and portfolio risk: an analysis based on copula functions

“…Bond and Patel (2003) proposed the use of a semi-variance risk measure; Hamelink and Hoesli (2004) used the maximum drawdown risk measure. With very few exceptions in real 266 M. Dulguerov estate literature, empirical analysis of the dependence structure relies on correlation coefficients.…”