Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
5091167 | Journal of Banking & Finance | 2006 | 19 Pages |
Abstract
When identifying optimal portfolios, practitioners often impose a drawdown constraint. This constraint is even explicit in some money management contracts such as the one recently involving Merrill Lynch' management of Unilever's pension fund. In this setting, we provide a characterization of optimal portfolios using mean-variance analysis. In the absence of a benchmark, we find that while the constraint typically decreases the optimal portfolio's standard deviation, the constrained optimal portfolio can be notably mean-variance inefficient. In the presence of a benchmark such as in the Merrill Lynch-Unilever contract, we find that the constraint increases the optimal portfolio's standard deviation and tracking error volatility. Thus, the constraint negatively affects a portfolio manager's ability to track a benchmark.
Related Topics
Social Sciences and Humanities
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Economics and Econometrics
Authors
Gordon J. Alexander, Alexandre M. Baptista,