Risk measure selection

Also seen as: Risk measure (the control label), risk metric, risk proxy

Why does the choice of risk measure change the weights?

The two measures look at different things. Volatility counts every swing across the whole window, up and down alike, and says nothing about where those swings led. Max drawdown counts a single event — the deepest fall from a previous peak — and ignores how choppy the ride was otherwise. So an instrument that grinds steadily downhill can look calm on volatility and terrible on drawdown, while one that lurches around but keeps recovering can look wild on volatility and mild on drawdown. Whichever measure you pick becomes the working definition of "calm" that the method weights by.

Which allocation method uses the risk measure?

The Risk measure control belongs to the Inverse Volatility method, whose description reads "Less-volatile instruments receive higher weights". Textbook inverse-risk weighting gives each instrument a weight proportional to 1 ÷ its risk and then normalizes so the weights sum to 100%, so the instrument the chosen measure calls calmest receives the largest weight. The control's hint states both options plainly: "Annualized volatility = how much the price fluctuates · Max drawdown = its worst historical loss".

Defaults in Fincanva

• The control is labelled Risk measure and offers exactly two options: "Annualized volatility" and "Max drawdown".
• The window each measure is computed over is the profile's In-sample setting, in months — "Historical window used by the active method for volatility, correlation, beta, and similar calculations. Default 12."
• Annualized volatility follows the standard 252-trading-day convention (the daily figure × √252) — see volatility.
• The risk measure belongs to the allocation profile, so a Risk-On and a Risk-Off profile can weight by different measures — see allocation and allocation method.

Worked example

Two instruments over the same 12-month window. Instrument A shows annualized volatility of 12% and a max drawdown of 35% — a slow, steady slide. Instrument B shows annualized volatility of 20% and a max drawdown of 18% — choppy, but it kept bouncing back. Weighting each in proportion to 1 ÷ its risk:

Same two instruments, same window, opposite ordering — under volatility A is the calm one and takes almost two-thirds of the capital; under max drawdown B is the calm one and takes almost two-thirds. That reversal is the whole point of the setting: you are choosing which kind of risk the weights should shrink away from.

Fincanva does not give investment advice, including which risk measure to use — see Is this financial advice?.