Implementing and testing the Maximum Drawdown at Risk

- Maximum Drawdown at Risk is a tool for controlling risk and preserving investment's capital.
- It is the most important risk measure for hedge fund managers and commodity trading advisors.
- Eight world stock indices are used to illustrate the methodology based on Monte Carlo simulations.
- The MDD model-based estimates are very accurate and respond quickly to changes in the volatility level.

Financial managers are mainly concerned about long lasting accumulated large losses which may lead to massive money withdrawals. To assess this risk feeling we compute the Maximum Drawdown, the largest price loss of an investment during some fixed time period. The Maximum Drawdown at Risk has become an important risk measure for commodity trading advisors, hedge funds managers, and regulators. In this study we propose an estimation methodology based on Monte Carlo simulations and empirically validate the procedure using international stock indices. We find that this tool provides more accurate market risk control and may be used to manage portfolio exposure, being useful to practitioners and financial analysts.