And Chief Economist Capital Market Consultants

One of the challenges of using downside risk measures as an alternative constructor of portfolios and diagnostic devise is in their computational intensity. This paper outlines how to use downside risk measures to construct efficient portfolios and to evaluate portfolio performance in light of investor loss aversion. Further, this paper advocates the use of distributional scaling to forecast price movement distributions. This paper could be subtitled, “Strategic Asset Allocation is Dead, ” in light of the simulation results. 1 What is so efficient about the “efficient frontier? ” The standard method of constructing the set of efficient portfolios, from which investors are to choose from, is to use the Markowitz (1952) model which defines risk as the standard deviation of a portfolio. Markowitz (1952) recognized that there are many different ways to define risk, but the standard deviation (or variance) of a portfolio is easier to calculate than alternatives. All portfolio optimization problems can be described as a sequence of mathematical programming problems. First, an analyst must construct a set of efficient frontiers, which ar