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Downside risk in multiperiod tracking error models

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Abstract

The recent crisis made it evident that replicating the performance of a benchmark is not a sufficient goal to meet the expectations of usually risk-averse investors. The manager should also consider that the investors are seeking downside protection when the benchmark performs poorly and thus they should integrate a form of downside risk control. We propose a multiperiod double tracking error portfolio model which combines these two goals and provides enough flexibility. In particular, the control of the downside risk is carried out through the presence of a floor benchmark with respect to which we can accept different levels of shortfall. The choice of a proper measure for downside risk leads to different problem formulations and investment strategies which can reflect different attitudes towards risk. The proposed model is tested through a set of out-of-sample rolling simulations in different market conditions.

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Acknowledgments

The authors thanks Dott. Fabio Lanza for the research assistance in the computational experiments, and two anonymous referees for useful comments.

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Authors and Affiliations

  1. Department of Economics, University Ca’ Foscari, Cannaregio 873, 30121 , Venice, Italy

    Diana Barro & Elio Canestrelli

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  1. Diana Barro
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  2. Elio Canestrelli
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Correspondence to Diana Barro.

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Barro, D., Canestrelli, E. Downside risk in multiperiod tracking error models. Cent Eur J Oper Res 22, 263–283 (2014). https://doi.org/10.1007/s10100-013-0290-y

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