Definition
Downside deviation measures the volatility of negative returns only, providing a more relevant risk metric than total standard deviation for investors who are primarily concerned about losses. It is the denominator of the Sortino ratio. The target return (minimum acceptable return or MAR) determines what counts as "downside"—typically the risk-free rate or zero.
functions Formula
DD = √[Σ min(Ri − MAR, 0)² / n]
lightbulb Example
Monthly returns: +3%, -2%, +4%, -5%, +1%, -3%, +6%, -1%. With MAR = 0%, only negative months count. Downside deviation ≈ 3.1%, while total std dev is 3.6%. The difference shows asymmetry in the return distribution.
verified_user Key Points
- Only counts returns below the target/threshold
- Denominator of the Sortino ratio
- More relevant than total vol for loss-averse investors
- Target return (MAR) determines what counts as downside