Shortfall Optimization Versus Minimum Variance for Equity Portfolios

Summary

The paper compares portfolios optimized to minimize shortfall with portfolios optimized to minimize variance. The empirical study uses Barra Extreme Risk and style factors such as Value, Growth, and Momentum across US, UK, and Japanese equity markets. It evaluates results over the period from 1985 to 2010, including performance in down markets.

The reported evidence indicates that shortfall minimization generally outperforms variance minimization, with the strongest relative results during market declines. The authors attribute this pattern to the optimizer’s factor tilts: it tends to favor more protective exposures such as Value and reduce exposure to more aggressive factors such as Growth and Momentum. Performance gains are largest when shortfall captures overall asymmetry rather than only extreme losses. These are historical empirical findings using a particular risk model and market sample; they do not establish that shortfall optimization will outperform across other periods, markets, or portfolio constraints.

Key ideas

• The study compares minimum-shortfall and minimum-variance equity portfolios using Barra Extreme Risk.
• The comparison covers US, UK, and Japanese equities and uses style factors including Value, Growth, and Momentum.
• Shortfall optimization generally performs better in the reported sample, particularly in down markets.
• Its relative performance is linked to greater exposure to protective factors and less exposure to aggressive factors.
• The strongest reported advantage comes from measuring overall asymmetry rather than only extreme losses.

Tags

# Minimizing Shortfall


# Minimizing Shortfall









This paper describes an empirical study of shortfall optimization with Barra Extreme Risk. We compare minimum shortfall to minimum variance portfolios in the US, UK, and Japanese equity markets using Barra Style Factors (Value, Growth, Momentum, etc.). We show that minimizing shortfall generally improves performance over minimizing variance, especially during down-markets, over the period 1985-2010. The outperformance of shortfall is due to intuitive tilts towards protective factors like Value, and away from aggressive factors like Growth and Momentum. The outperformance is largest for the shortfall that measures overall asymmetry rather than the extreme losses.

Shown in full with attribution under the source's licence. Licence: abstract CC0

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