|Published On: March 6th, 2013|Categories: Video Learning Series|

I’ve been thinking a lot about drawdowns recently. In fact, I was thinking so hard about them I wrote a paper with Jack Vogel on the subject!

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2226689

We propose the use of maximum drawdown, the maximum peak to trough loss across a time series of compounded returns, as a simple method to capture an element of risk unnoticed by linear factor models: tail risk. Unlike other tail-risk metrics, maximum drawdown is intuitive and easy-to-calculate. We look at maximum drawdowns to assess tail risks associated with market neutral strategies identified in the academic literature. Our evidence suggests that academic anomalies are not anomalous: all strategies endure large drawdowns at some point in the time series. Many of these losses would trigger margin calls and investor withdrawals, forcing an investor to liquidate.

Here is the source code for the MaxDD function:
Function drawdown(port_series As Range)
Application.EnableCancelKey = xlDisabled
‘ Find the biggest cumulative drawdown for a performance series
‘ dates = dates typically alongside the returns
‘ port_series = port_series returns in % * 100 format
Dim counter As Integer
Dim cume As Double
Dim max As Double
counter = 1
cume = 1
max = 1
For counter = 1 To port_series.Count
If port_series(counter).Value <> “–” Then
cume = (cume * (port_series(counter).Value + 1))
End If
If cume >= 1 Then
cume = 1
End If
If cume < max Then
max = cume
End If
Next counter
‘If there never was a drawdown
If max = 1 Then
drawdown = “N/A”
Else
drawdown = (max – 1)
End If
End Function

## About the Author: Wesley Gray, PhD

After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

## Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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