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Although the Sharpe Ratio is widely recognised as a measure of the
volatility of strategy performance, it arguably suffers from the fact that
it includes upside volatility in it's calculation, as well as downside.
Since we are principally interested in (the limitation of) drawdowns rather
than the volatility of favourable equity excursions, it would seem to make
some sense to exclude upside volatility from such a calculation, which, I
understand, is what the Return Retracement Ratio does (although I haven't
seen the formula for it - perhaps someone could tell me what it is).
My problem though, is that I cannot quite convince myself that the
statistics of upside volatility are necessarily unrelated to those of
downside volatility, depending on the characteristics of the system being
tested. In other words, if a backtested system has shown greater upside
volatility than downside in the past, how much trust could you give to the
notion that the ratio (of upside to downside volatility) might continue in a
similar way in the future? Can you be confident that upside volatility is
not also a valid predictor of downside volatility as well?
These are not rhetorical questions -the more I think about it the less
convinced I become one way or the other.
Unfortunately I have seen almost nothing on the Return Retracement Ratio
and it's advantages or disadvantages vis a vis the Sharpe Ratio. If some
kind soul could point me towards some relevant resource or share their own
thoughts I would appreciate it.
VT
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