Abstract
In Quantitative Finance 2016, Chen, Hu and Lin (CHL) claimed the following: ‘ … there is yet no coherent risk measure related to investment performance.’ (p. 682). Our paper suggests and analyzes four coherence axioms that portfolio performance ratios should satisfy. Our Portfolio Riskless Translation Invariance axiom must be satisfied to assure separation of the objective decision to optimize a portfolio’s risky composition from the subjective decision to optimize the weight of the portfolio's level of risk-free asset. Performance ratios with fixed thresholds other than the risk-free rate do not satisfy this axiom, allowing portfolio managers to affect an ex-ante performance ratio merely by changing the proportion of the risk-free asset in the portfolio rather than by improving the composition of the portfolio’s risky components. The magnitude of this potential drawback is examined using S&P-500 stock index data. Replacing the fixed threshold, T, with a threshold (Formula presented.) that equals γ times the portfolio’s risk premium plus (1-γ) times the risk-free rate, eliminates the above shortcoming for any selected γ. In addition, using performance ratios with threshold (Formula presented.) rather than fixed T, assures consistency of performance ratios of effective stochastic dominance and risk-free asset rules.
| Original language | English |
|---|---|
| Pages (from-to) | 1589-1603 |
| Number of pages | 15 |
| Journal | Quantitative Finance |
| Volume | 21 |
| Issue number | 9 |
| DOIs | |
| State | Published - 2021 |
| Externally published | Yes |
Bibliographical note
Publisher Copyright:© 2021 Informa UK Limited, trading as Taylor & Francis Group.
Keywords
- Coherent performance ratios
- Coherent risk measures
- Downside risk measures
- FSDR and SSDR rules
- Kappa ratio
- Lower partial moments
- Omega ratio
- Sortino ratio
- Stochastic dominance