Economics Risk And Return Questions Medium
Downside deviation is a statistical measure used to assess the risk associated with an investment or portfolio. It specifically focuses on the negative returns or losses that occur below a certain threshold or target return.
Unlike standard deviation, which considers all deviations from the mean (both positive and negative), downside deviation only takes into account the deviations below a specified threshold. It provides a more accurate measure of the downside risk or volatility of an investment.
Downside deviation is particularly useful for investors who are more concerned about the potential losses or downside risk of their investments. By focusing on the negative returns, it helps investors understand the potential downside they may face and make more informed decisions.
To calculate downside deviation, the following steps can be followed:
1. Determine the threshold or target return below which negative returns are considered.
2. Calculate the deviations of the returns that fall below the threshold.
3. Square each deviation to eliminate the negative signs.
4. Sum up all the squared deviations.
5. Divide the sum by the number of observations.
6. Take the square root of the result to obtain the downside deviation.
Overall, downside deviation provides a more comprehensive understanding of the risk associated with an investment by focusing on the potential losses. It helps investors make more informed decisions and manage their portfolios effectively.