Application of Performance Ratios in Portfolio Optimization

• Main Author: Aleš Kresta
• Format: Article
• Language: English
• Published: Mendel University Press 2015-01-01
• Series: Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis
• Subjects: portfolio optimization; Sharpe ratio; mean absolute deviation ratio; Rachev ratio; efficient market hypothesis; time series modelling
• Online Access: https://acta.mendelu.cz/63/6/1969/

The cornerstone of modern portfolio theory was established by pioneer work of Harry Markowitz. Based on his mean-variance framework, Sharpe formulated his well-known Sharpe ratio aiming to measure the performance of mutual funds. The contemporary development in computer’s computational power allowed to apply more complex performance ratios, which take into account also higher moments of return probability distribution. Although these ratios were proposed to help the investors to improve the results of portfolio optimization, we empirically demonstrated in our paper that this may not necessarily be true. On the historical dataset of DJIA components we empirically showed that both Sharpe ratio and MAD ratio outperformed Rachev ratio. However, for Rachev ratio we assumed only one level of parameters value. Different set-ups of parameters may provide different results and thus further analysis is certainly required.