Drawdown-Constrained Capital Allocation

The question

Optimal leverage and position sizing when capital faces a hard drawdown barrier and the edge itself is estimated, not known. Develops the Bayesian Grossman–Zhou rule and dynamic de-risking (DDR) policies that nest the classical Grossman–Zhou model as a limiting case, and benchmarks them against the true HJB optimum across GBM, regime-switching, Student-t, jump-diffusion and GARCH environments.

Bayesian Grossman–Zhou Rule

κ̄(n)

posterior mean edge, shrunk by effective sample size

d

normalised distance to the drawdown barrier

b

reward-to-risk ratio

Working papers