V.3:1 (22-25): Probability of Investment Ruin by Sherwin Kalt

V.3:1 (22-25): Probability of Investment Ruin  by Sherwin Kalt
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Probability of Investment Ruin by Sherwin Kalt

When a client opens a managed account with as commodity trading advisor, the general practice is to specify a percentage loss at which the account will be closed. The natural question then arises as to what are the chances that this will happen within a given time period, for example, six months or a year. Given certain empirically determined characteristics of the trading system, this paper provides a method for solving this problem directly. The method can also be used in analyzing investments other than commodity managed accounts. It can be used in any case where the assumptions made are found applicable.

Decisions are presently being made by prospective investors without explicit knowledge as to the risk of ruin (i.e. account closing) that is being taken. Parameters, such as the Sharpe ratio, or the standard deviation of the rate of return, are only of use in ranking trading systems in some general order. Lack of knowledge of the risk being taken can lead to disillusionment on the part of the investor. In the long term the situation is very harmful to the industry. It is hoped that this paper will increase the capability to quantify the characteristics of trading systems being analyzed. The result will be more informed decisions on the part of the investment community.

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