Extreme Returns, Downside Risk, and Optimal Asset Allocation

Abstract

The issue of asset allocation is important to every investor, but because of common, yet questionable, assumptions, these allocations may be significantly biased. Perhaps the most common investor assumption is normality or lognormality of asset returns. Evidence indicates, however, that return distributions often have fat tails (i.e., are leptokurtic). If so, how far from optimality are these “optimal” allocations?

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