The Sortino Ratio and Extreme Value Theory: An Application to Asset Allocation

G. Geoffrey Booth*, John Paul Broussard

*Corresponding author for this work

Research output: Chapter in Book/Report/Conference proceedingChapterScientific

1 Citation (Scopus)

Abstract

This chapter applies extreme value theory (EVT) techniques when using the Sortino ratio for selecting optimal portfolio weights. The analysis is restricted to two assets for simplicity, with one of the assets being a portfolio of the U.S. real estate investment trusts (REIT) and the other a broad-based portfolio of U.S. equities represented by the S&P 500 stock index. The chapter uses an extensive daily dataset to calculate the Sortino ratio using various two-asset allocation weights. It repeats the calculations after replacing the empirical data by a fitted generalized Pareto distribution (GPD). The chapter compares the Sortino ratio asset allocation results provided by the various scenarios to the portfolio suggested by the Sharpe ratio. The study contributes to two strands of the performance and asset allocation literature. Future research should be directed towards implications of downside risk and notion of a conditional Sortino ratio.

Original languageEnglish
Title of host publicationExtreme Events in Finance: A Handbook of Extreme Value Theory and its Applications
EditorsFrançois Longin
Place of PublicationHoboken, New Jersey
PublisherJohn Wiley & Sons
Publication date2017
Pages443-464
ISBN (Print)978-1-118-65019-6
ISBN (Electronic)978-1-118-65031-8
DOIs
Publication statusPublished - 2017
MoE publication typeB2 Book chapter

Keywords

  • 512 Business and Management
  • Asset allocation
  • Extreme value theory
  • Normal distribution overlay
  • Pareto distribution
  • Real estate investment trusts
  • Sharpe ratio
  • Sortino ratio
  • U.S. equities

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  • Cite this

    Booth, G. G., & Broussard, J. P. (2017). The Sortino Ratio and Extreme Value Theory: An Application to Asset Allocation. In F. Longin (Ed.), Extreme Events in Finance: A Handbook of Extreme Value Theory and its Applications (pp. 443-464). Hoboken, New Jersey: John Wiley & Sons. https://doi.org/10.1002/9781118650318.ch17