When Do Distributional Alarms Improve Downside Risk Control? Evidence from Four Equity Markets (Research Square)

Summary

• Across seven historical market episodes, the DRP monitor detects 21 of 28 cases compared to 15 for RV22.p.3
• DRP covers 84.19% of maximum drawdown simple-return severity versus 75.02% for RV22.p.4
• Increasing the DRP-only cut from 0% to 25% improves the shared-tail mean return by 0.061 percentage points while reducing certainty equivalent by 0.123 percentage points.p.10

Key insights

1. Cutting exposure by 25% on DRP-only dates improves return on common extreme dates by 0.061 percentage points over a fixed RV22 rule.p.2
2. The distributional overlay lowers volatility by 0.081 percentage points and maximum drawdown by 1.303 percentage points compared to an equal-target RV22 control on an exchange grid.p.6
3. Holding more equity on volatility-only dates generates the single largest positive contribution (+0.214 percentage points) to the certainty-equivalent difference over equal-target RV22.p.9
4. The own-tail mean performance gap between the overlay and equal-target RV22 is +0.022 percentage points, but changes sign to -0.072 percentage points on shared unhedged index extreme dates.p.7
5. Excluding the S&P 500 reduces the certainty-equivalent gap between the overlay and equal-target RV22 from +0.147 percentage points to +0.018 percentage points.p.6
6. Deepening the DRP-only cut improves downside tail metrics monotonically but lowers overall annualized net return and certainty equivalent.p.10
7. Introducing an extra session of execution lag increases the certainty-equivalent gap between the overlay and equal-target RV22 to +0.290 percentage points.p.10