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Title: | A Rational Risk Policy? Why Path Dependence Matters | Authors: | GEBOERS, Hans DEPAIRE, Benoit |
Issue Date: | 2023 | Publisher: | MDPI | Source: | Entropy, 25 (2) (Art N° 202) | Abstract: | The Kelly criterion determines optimal bet sizes that maximize long-term growth. While growth is definitely an important consideration, the focus on growth alone can lead to significant drawdowns, leading to psychological discomfort for a risk-taker. Path-dependent risk measures, such as drawdown risk, provide a means to assess the risk of significant portfolio retracements. In this paper, we provide a flexible framework for assessing path dependent risk for a trading or investment operation. Given a certain set of profitable trading characteristics, a risk-taker who maximizes expected growth can still be faced with significant drawdowns to the point where a strategy becomes unsustainable. We demonstrate, through a series of experiments, the importance of path dependent risks in the case of outcomes subject to various return distributions. Based on Monte Carlo simulation, we analyze the medium-term behavior of different cumulative return paths and study the impact of different return outcome distributions. We show that in the case of heavier tailed outcomes, extra care is needed, and optimal might not be so optimal in the end. | Notes: | Geboers, H (corresponding author), Hasselt Univ, Quantitat Methods, Res Grp Business Informat, B-3500 Hasselt, Belgium. hans.geboers@uhasselt.be |
Keywords: | path dependence;optimal leverage;risk management;Kelly criterion | Document URI: | http://hdl.handle.net/1942/39812 | e-ISSN: | 1099-4300 | DOI: | 10.3390/e25020202 | ISI #: | 000938789400001 | Rights: | 2023 by the authors. Licensee MDPI, Basel, Switzerland. This article is an open access article distributed under the terms and conditions of the Creative Commons Attribution (CC BY) license (https:// creativecommons.org/licenses/by/ 4.0/). | Category: | A1 | Type: | Journal Contribution |
Appears in Collections: | Research publications |
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A Rational Risk Policy_ Why Path Dependence Matters.pdf | Published version | 7.06 MB | Adobe PDF | View/Open |
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