Drawdown (economics)

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Drawdown is the measure of the decline from a historical peak in some variable (e.g., the variable of interest might be the cumulative profit since inception from the purchase of a share of common stock). Somewhat more formally, if X(t) is a random process [X(0) = 0, t \geq 0], the drawdown at any time, T, is defined as - Min \lbrack 0, X(T) - Max_{t \in (0,T)} \lbrack X(t) \rbrack \rbrack

In finance, the use of drawdown as an indicator of risk is particularly popular in the Commodity Trading Advisors - CTA world with the derivation of three performance measures: the Calmar Ratio, the Sterling Ratio and the Burke Ratio. These measures can be considered as a modification of the Sharpe ratio in the sense that the numerator is always the excess of mean returns relatively to a risk-free rate while the standard deviation of returns in the denominator is replaced by other compilations of drawdown.

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