Downside risk - Financial definition

Downside risk is a critical concept in risk management and portfolio optimization. It specifically measures the risk of negative returns, focusing on the lower tail of the return distribution. Unlike standard deviation, which considers both upside and downside volatility, downside risk only considers the potential for losses. For example, investors often use metrics such as Value at Risk (VaR) or Conditional Value at Risk (CVaR) to assess downside risk, helping them to mitigate potential losses during market downturns. In practice, financial advisors and fund managers may adjust asset allocations to minimize downside risk, especially in volatile markets or for risk-averse clients.