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Hedge Fund Allocation under Higher Moments and Illiquidity
Mälardalen University, Department of Mathematics and Physics.
2005 (English)In: HEDGE FUNDS: INSIGHTS IN PERFORMANCE MEASUREMENT, RISK ANALYSIS, AND PORTFOLIO ALLOCATION, John Wiley & Sons , 2005Chapter in book (Other academic)
Abstract [en]

We use the discrete-time dynamic investment model to evaluate the gains from including hedge funds in the investment opportunity set. In this multi-period framework, an investor's utility is affected by all moments of the return distribution. We assume that investors rebalance their portfolios on a monthly basis, and we compare the performance of portfolios which may include hedge funds versus portfolios consisting of stocks and bonds only. Our findings show that: (1) investors will allocate wealth to hedge funds even when they take into account deviations from normality in hedge fund returns. Those ex ante optimal allocations result in portfolios that ex post have higher geometric returns compared to the case in which hedge fund investing is not permitted; (2) investors that form portfolios taking all moments of the return distribution into account construct portfolios that are very similar to the portfolios being constructed by investors who care only about expected return and standard deviation, suggesting that the two first moments of the return distribution dominate higher moments; (3) the positive effect on capital growth from including hedge funds into the portfolios remains, although smaller, when the so-called "stale-pricing effect" is considered; and (4) lock-up periods and advance notice periods may force investors to have portfolios that deviate from their targeted ex ante optimal portfolios. Through a simple experiment we show that this inability to rebalance hedge fund allocations may seriously impact the benefits that hedge fund allocations appear to offer.

Place, publisher, year, edition, pages
John Wiley & Sons , 2005.
Keywords [en]
hedge funds, asset allocation, international investment
National Category
Computational Mathematics Economics and Business
Identifiers
URN: urn:nbn:se:mdh:diva-3410ISBN: 0-471-73743-7 (print)OAI: oai:DiVA.org:mdh-3410DiVA, id: diva2:116074
Available from: 2007-04-27 Created: 2007-04-27 Last updated: 2015-07-28Bibliographically approved

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CiteExportLink to record
Permanent link

Direct link
Cite
Citation style
  • apa
  • ieee
  • modern-language-association-8th-edition
  • vancouver
  • Other style
More styles
Language
  • de-DE
  • en-GB
  • en-US
  • fi-FI
  • nn-NO
  • nn-NB
  • sv-SE
  • Other locale
More languages
Output format
  • html
  • text
  • asciidoc
  • rtf