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Interpreting Maximum Drawdown and Annualized Standard Deviation as Risk Measures

Article Quant Q&A · Author: Citizen
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Summary

The document compares maximum drawdown (MDD) and annualized standard deviation (ASD) as measures used to assess hedge-fund risk. Its answer says that a larger drawdown often indicates greater volatility, but the relationship is not reliable in every case. A fund can fall substantially from a high-water mark while still ending the measurement period with a positive return; another fund with a smaller drawdown may have a different path and endpoint.

The answer treats standard deviation as a more direct measure of return variability around the average: a larger ASD generally means returns fluctuate more and are therefore regarded as riskier. The examples are illustrative rather than a formal comparison of complete return series. Neither statistic captures every dimension of risk, and the document gives no details about the return frequency, annualization convention, measurement window, or other risk measures that would be needed to interpret reported fund figures fully.

Key ideas

  • Maximum drawdown measures the decline from a peak, but does not by itself fully describe a fund's return path.
  • A larger maximum drawdown often signals greater volatility, though it does not guarantee it.
  • Standard deviation measures how much returns vary around their average.
  • A larger annualized standard deviation is generally interpreted as greater return variability and risk.

Tags

Risk managementStatisticsMulti-asset
Full text
# How should I interpret MDD and ASD?


# How should I interpret MDD and ASD?












I'm studying hedge funds and I'm looking at two figures that I'm not sure how to interpret:

The first is Max Drawdown, which I see scaling from 0 to -30ish.

Is Fund A with a MDD of -15 more or less volatile than Fund B with a MDD of -30?

The second is Annualized Standard Deviation, which I see scaling from 0 to 400ish.

Is Fund A with a ASD of 40 more or less volatile than Fund B with a ASD of 350?

## Answer by Rime (score 2, accepted)

https://quant.stackexchange.com/a/15941

To answer the first question: Typically a higher drawdown = more volatile but not all the time. For example, Fund B can have a high watermark of 30% return but end the period at 0% return & therefore have a MDD of -30%. Fund A can have a high watermark of ; 30% return ,but end the period at 15% return therefore have a MDD of -15%. Over this period, Fund B is more volatile since it went from +30% to 0. To answer the second question: in finance standard deviation will most typically = risk. A higher SD is more risky as a return will fluctuate more from its average. Therefore Fund B is more volatile/risky.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.