Economics Risk And Return Questions Medium
The downside deviation is a measure of the volatility or risk associated with the negative returns of an investment or portfolio. It is calculated by taking the square root of the average squared deviations of returns that fall below a specified threshold or minimum acceptable return.
To calculate the downside deviation, follow these steps:
1. Determine the minimum acceptable return or threshold below which returns are considered negative. This threshold is typically set at zero, assuming that any return below zero is considered a negative return.
2. Calculate the deviation of each return that falls below the threshold by subtracting the threshold from the return. If the return is above the threshold, the deviation is zero.
3. Square each deviation to eliminate negative values and emphasize the magnitude of the deviations.
4. Calculate the average of the squared deviations by summing up all the squared deviations and dividing by the total number of observations.
5. Take the square root of the average squared deviations to obtain the downside deviation.
The downside deviation provides a more accurate measure of risk by focusing on the negative returns, which are typically of greater concern to investors. It helps investors assess the potential downside risk associated with an investment or portfolio and make informed decisions based on their risk tolerance and investment objectives.