Optimal allocation using the Sortino ratio

TL;DR

This paper introduces an asset allocation method that maximizes the Sortino ratio, focusing on downside risk, and demonstrates its effectiveness over traditional strategies like Kelly using historical data.

Contribution

It presents a novel allocation strategy based on maximizing the Sortino ratio, which is more sensitive to downside risk than traditional measures.

Findings

The strategy outperforms Kelly criterion in historical Dow Jones data

The allocation method is applicable for any time horizon

Empirical results show significant improvement over traditional methods

Abstract

In this paper we present an asset allocation strategy based on the maximization of the Sortino ratio. Unlike the Sharpe ratio, the Sortino ratio penalizes negative return variances only. The resulting allocation is valid for any time horizon unlike. The returns of a strategy based on such an allocation are empirically illustrated using historical Dow Jones data and display a significant upgrade on more traditional allocation strategies such as the Kelly criterion.