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Pitfalls of Downside Performance Measures with Arbitrary Targets
Author(s) -
Hoechner Benedikt,
Reichling Peter,
Schulze Gordon
Publication year - 2017
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/irfi.12137
Subject(s) - downside risk , sharpe ratio , benchmark (surveying) , econometrics , asset (computer security) , information ratio , economics , actuarial science , computer science , financial economics , portfolio , computer security , geodesy , geography
Downside performance measures relate above target returns with lower partial moments. They were developed to resolve restrictive assumptions of the classical Sharpe ratio. While the Sharpe ratio evaluates whether portfolios of a mutual fund and the risk‐free asset dominate passive portfolios of the benchmark and the risk‐free asset, this characteristic cannot be transferred to downside performance measures with arbitrary targets. We show that downside performance measures assign different values to passive benchmark strategies if the target differs from the risk‐free rate. This effect can lead to reverse rankings of financial assets. Therefore, downside performance measures are only applicable in asset management if the target is set equal to the risk‐free rate.