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Article

Non-Normality of Market Returns: A Framework for Asset Allocation Decision Making

Abdullah Z Sheikh and Hongtao Qiao
The Journal of Alternative Investments Winter 2010, 12 (3) 8-35; DOI: https://doi.org/10.3905/JAI.2010.12.3.008
Abdullah Z Sheikh
is director of research in the Strategic Investment Advisory Group at J.P. Morgan Asset Management in New York, NY.
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  • For correspondence: abdullah.z.sheikh@jpmorgan.com
Hongtao Qiao
is a strategic advisor in the Strategic Investment Advisory Group at J.P. Morgan Asset Management in New York, NY.
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  • For correspondence: hongtao.j.qiao@jpmorgan.com
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Abstract

When market stress and disruptions hit portfolios especially hard, it is natural for investors to ask if anything could have been done differently. The turmoil of 2007–2009 is just one among many such financial crises over the past 30 years— rare and unpredictable events that can, and should, challenge conventional ideas about portfolio construction. And often, it is in such times of reflection that one arrives at important insights and begins to craft effective solutions. This article presents a statistical methodology that can incorporate three categories of non-normality; serial correlation, “fat” left tails (negative skew and leptokurtosis), and correlation breakdown (converging correlations). The results show that extreme negative events due to “non-normality” of asset returns are observed with much higher frequency than current risk frameworks allow for. Consequently, traditional asset allocation frameworks that are based on assumptions of normality in asset returns can significantly understate portfolio downside risk. The authors conclude that incorporating nonnormality can lead to more efficient portfolios.

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The Journal of Alternative Investments: 12 (3)
The Journal of Alternative Investments
Vol. 12, Issue 3
Winter 2010
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Non-Normality of Market Returns: A Framework for Asset Allocation Decision Making
Abdullah Z Sheikh, Hongtao Qiao
The Journal of Alternative Investments Dec 2009, 12 (3) 8-35; DOI: 10.3905/JAI.2010.12.3.008

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Non-Normality of Market Returns: A Framework for Asset Allocation Decision Making
Abdullah Z Sheikh, Hongtao Qiao
The Journal of Alternative Investments Dec 2009, 12 (3) 8-35; DOI: 10.3905/JAI.2010.12.3.008
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  • Article
    • Abstract
    • EMPIRICAL EVIDENCE OF NON-NORMALITY IN ASSET RETURNS
    • APPENDIX A
    • APPENDIX B
    • ENDNOTES
    • REFERENCES
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