Maximum Drawdowns of Hedge Funds with Serial Correlation

Abstract

Maximum drawdown, the maximum peak-to-trough loss in net asset value (NAV), is a widely-used risk measure among alternative investment investors. Analogous to value-at-risk, a-percentile maximum-drawdown-at-risk (MDaR) is the maximum drawdown such that a fund recovers its peak NAV a-percent of the time before reaching it. In this article formulas for MDaR are derived, depending on a fund's mean return, volatility and serial correlation. The model-based MDaR are compared with historical MDaR of hedge fund indexes and simulated MDaR of an autoregressive model.