Portfolio Theory is Alive and Well

A Brief History of Downside Risk Measures

“…a s 10.0 , the R͞SV ratio decreases from 0.20 to 0.18, indicating reduced risk-return performance as the skewness increases. w x Contrary to Kaplan and Siegel 1994a , an Ž . investor can use the Fishburn a, t to approach a risk-neutral position over time by setting the parameter a to a value of 1.0, which is risk-neutral.…”

“…The battle has been joined most recently w in this journal by Rom and Ferguson 1993, x w 1994b and Kaplan andSiegel 1994a, x 1994b in what I would characterize as a tempest in a teapot. Let me say at the outset that I am a strong supporter of downside risk measures and have used them in my teaching, research, and software for twenty years.…”

“Portfolio Theory is Alive and well”

“…The explanation of the bizarre behavior of MVO is that, as Kaplan and Siegel [1994] remind us, MVO assumes that investors hate risk as represented by variance. In this example, MVO loves low variance so much that it causes myopic behavior.…”

“…This is an excellent example of what Arnott [1994] calls "reckless conservatism." We now use risk tolerance, the portfolio selection technique recommended by Kaplan and Siegel [1994], to show that: a rational investor could unwittingly select an unreasonable portfolio from the MVO efficient fr~ntier.~ The level of risk tolerance used is that of a moderately conservative in~estor.~ The portfolio selected consists of 48% in Hi-Asset and 52% in Lo-Asset.…”

“…Three years later, responding to our original article [1993] and to Kaplan and Siegel [1994], he wrote [ 19941 :…”