Optimal Hedge Fund Allocation with Improved Estimates for Coskewness and Cokurtosis Parameters

Since hedge fund returns are not normally distributed, mean-variance optimisation techniques, which would lead to substantial welfare losses from the investor’s perspective, need to be replaced by optimisation procedures incorporating higher-order moments and comoments.

Author(s):

Asmerilda Hitaj

Junior researcher at the University of Milano - Bicocca (Italy).

Lionel Martellini

Professor of finance at EDHEC Business School and scientific director of EDHEC-Risk Institute.

Giovanni Zambruno

Holds the chair of Mathematical Finance at the University of Milano - Bicocca.

In this context, optimal portfolio decisions involving hedge fund style allocation require not only estimates for covariance parameters but also estimates for coskewness and cokurtosis parameters. This is a formidable challenge that severely exacerbates the dimensionality problem already present with mean-variance analysis. This paper presents an application of the improved estimators for higherorder co-moment parameters, recently introduced by Martellini and Ziemann (2010), in the context of hedge fund portfolio optimisation. We find that the use of these enhanced estimates generates a significant improvement for investors in hedge funds. We also find that it is only when improved estimators are used that portfolio selection with higherorder moments consistently dominates mean-variance analysis from an out-ofsample perspective. Our results have important potential implications for hedge fund investors and hedge fund of funds managers who routinely use portfolio optimisation procedures incorporating higher moments.

Type: EDHEC Publication
Date: le 28/09/2010
Research Cluster : Finance

See Also

EDHEC career support at distance: continuous follow-up and a highly active network
News
- 05-06-2020
After fully digitalising its services, the EDHEC Student Career Centre has been...
How I got my dream internships
News
- 02-06-2020
I originally wanted to be a footballer. I daydreamed about training with the top...
« EDHEC, the best experience of my life so far »
News
- 29-05-2020
WHAT IS YOUR EDUCATIONAL BACKGROUND PRIOR TO EDHEC? Prior to EDHEC, I pursued a...
Meet Valentin Grinner, Pre-Master student
News
- 28-05-2020
Valentin Grinner “I’ve started a MOOC to learn web development” Valentin, 20, is...