Robust Assessment of Hedge Fund Performance through Nonparametric Discounting

Caio Almeida, René Garcia: This study, produced as part of the Newedge research chair on “Advanced Modelling for Alternative Investments,” Proposes a Robust New Method for Assessing Hedge Fund Performance.

Author(s):

Caio Almeida

PhD in Electrical Engineering from Catholic University in Rio, and post-doctorate degree from the Department of Mathematics at Stanford University.

Rene Garcia

Professor of Finance at EDHEC Business School and the Academic Director of the EDHEC-Risk Institute PhD in Financeprogramme.

This methodology is applied to various hedge fund indices as well as to individual hedge funds, considering a set of risk factors including equities, bonds, credit, currencies and commodities. The research findings strongly suggest that what was incorrectly measured as hedge fund alpha in previous studies is actually some form of fair reward obtained by hedge fund managers from holding a set of relatively complex linear and non-linear exposures with respect to various risk factors. Often the reduction in performance comes from a small number of extreme events which are not captured well with the usual linear approach. The findings also support the view that higher-moment equity risks capture a large part of the non-linear risk exposure of several hedge fund strategies. However, exposure to higher-moment risks for bond, interest rate or currency is essential for other strategies, in particular Emerging Markets. Finally, the authors illustrate with individual funds how a fund manager can measure the sensitivity of his portfolio of funds to shocks affecting risk factors, that is macro shocks, or to idiosyncratic shocks impacting a particular fund. This new approach can be extended to evaluate hedge fund managers' performance conditionally to specific macroeconomic environments such as high or low interest-rate states, large or limited economic uncertainty, bull or bear markets, and liquid or illiquid markets, making the performance measurement more transparent to general economic conditions.

Type: EDHEC Publication
Date: le 25/06/2012
Research Cluster : Finance

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