Combining Upside and Downside Volatility in Investment Decision

This paper deals with asset allocation decisions when the considered risk measure is directly related to the investor's level of risk aversion. It is well known that the optimal portfolio weights are considerably sensitive to how assets are ranked on the basis of their risk-return profile. We propose a procedure to construct optimal portfolios that adapt quickly to changes in risk using a time varying asset allocation model based on a modified Sharpe Ratio measure related to downside and upside risk weighted using an aversion parameter. The model is applied, as an illustrative example, to six stock markets located in Western Europe basing the analysis on monthly data covering the period January 2000-December 2020.