Drawdown and Tail Risk

Every measure so far — variance, standard deviation, beta, Sharpe — treats an unusually good year and a ruinous one as equally “risky.” That is not a subtlety to note and move past. It is the central defect, and it is why section “MPT Under Deep Uncertainty” argues that variance has mislabeled the only risk that matters. You are never wiped out by an upside surprise.

The measures in this section fix that asymmetry. They are what the tail-hedging arguments in chapter “Derivatives” and the survival-first framing in chapter “Asset Allocation” are implicitly about, and they are what you should look at first when someone hands you a track record.