Portfolio models for optimizing drawdown duration

Andrei Vedernikov*, Juuso Liesiö, Tomi Seppälä

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

Abstract

The drawdown duration, which measures the time elapsed since the portfolio obtained its maximum value, is an important criterion in active portfolio management for institutional investors. Although several optimization models exist for controlling portfolio drawdown magnitude (i.e. the percentage drop in portfolio value from its latest peak value), developing similar models for the drawdown duration has received minimal attention in the literature. Therefore, this paper develops a family of models for optimizing average, maximum and tail drawdown duration formulated as mixed-integer linear programming (MILP) problems, allowing the utilization of powerful solvers to identify optimal asset portfolios. We apply the developed models to real data on historical returns to compare their performance against traditional and drawdown-based portfolio selection models. The results indicate that the developed models lead to decrease in drawdown duration levels both in in-sample and out-of-sample tests. The constructed efficient frontiers also show a clear trade-off between minimizing drawdown duration and maximizing expected returns.

Original languageEnglish
Article number2450014
JournalInternational Journal of Theoretical and Applied Finance
Volume27
Issue number2
DOIs
Publication statusPublished - 1 Mar 2024
MoE publication typeA1 Journal article-refereed

Keywords

  • drawdown
  • Finance
  • mixed-integer linear programming
  • portfolio optimization

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