Optimal Strategies Under Omega Ratio

Abstract

We study optimal investment strategies under the objective of maximizing the Omega ratio, proposed by Keating and Shadwick (2002) as an alternative to the Sharpe ratio for performance assessment of investment strategies. We show that in a standard set-up of the financial market the problem is ill-posed, i.e., maximizing the Omega ratio leads to excessive risk taking. By imposing additional restrictions we show that the Omega ratio maximizing strategy is still very risky and may coincide with the choice made by risk neutral investors. We conclude that caution is needed when using the Omega ratio for making asset allocation decisions.

Keywords: Portfolio choice, Omega ratio, Ill-posedness