Los 5.c

Question 1

What is shortfall risk?

Answer 1

Shortfall risk is the probability that a portfolio’s value or return will fall below a particular target value or return over a given period.

Question 2

What does Roy’s safety-first criterion aim to minimise? And how to calculate?

Answer 2

Defintion: It aims to minimize the probability that the portfolio return falls below a minimum acceptable level (threshold level).
Calculating: P(Rp < RL), Rp = Portfolio Return, RL = threshold level return
If portfolio returns are normally distributed: Roy’s safety first criterion can be stated as follows, maximises safety-first ration: (E(Rp)-RL) / Standard deviation P