Hostname: page-component-78c5997874-s2hrs Total loading time: 0 Render date: 2024-11-15T01:26:17.315Z Has data issue: false hasContentIssue false
  • English
  • Français

Hedge Fund Return Predictability Under the Magnifying Glass

Published online by Cambridge University Press:  22 August 2013

Doron Avramov ,
Laurent Barras  and
Robert Kosowski
Doron Avramov
Affiliation:
davramov@huji.ac.il, School of Business Administration, Hebrew University of Jerusalem, Mount Scopus, Jerusalem 91905, Israel
Laurent Barras
Affiliation:
laurent.barras@mcgill.ca, Desautels Faculty of Management, McGill University, 1001 Sherbrooke St W, Montreal QC H3A 1G5, Canada
Robert Kosowski
Affiliation:
r.kosowski@imperial.ac.uk, Business School, Imperial College London, South Kensington Campus, Exhibition Rd, London SW7 2AZ, United Kingdom.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper develops a unified approach to comprehensively analyze individual hedge fund return predictability, both in and out of sample. In sample, we find that variation in hedge fund performance across changing market conditions is widespread and economically significant. The predictability pattern is consistent with economic rationale, and largely reflects differences in key hedge fund characteristics, such as leverage or capacity constraints. Out of sample, we show that a simple strategy that combines the funds’ return forecasts obtained from individual predictors delivers superior performance. We exploit this simplicity to highlight the drivers of this performance, and find that in- and out-of-sample predictability are closely related.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 48 , Issue 4 , August 2013 , pp. 1057 - 1083
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2013 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Agarwal, V., and Naik, N. Y.. “Risks and Portfolio Decisions Involving Hedge Funds.” Review of Financial Studies, 17 (2004), 63–98.Google Scholar
Amihud, Y.; Hurvich, C. M.; and Wang, Y.. “Multiple-Predictor Regressions: Hypothesis Testing.” Review of Financial Studies, 22 (2008), 414–434.Google Scholar
Avramov, D. “Stock Return Predictability and Model Uncertainty.” Journal of Financial Economics, 64 (2002), 423–458.CrossRefGoogle Scholar
Avramov, D.; Kosowski, R.; Naik, N. Y.; and Teo, M.. “Hedge Funds, Managerial Skill, and Macroeconomic Variables.” Journal of Financial Economics, 99 (2011), 672–692.Google Scholar
Barras, L.; Scaillet, O.; and Wermers, R.. “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas.” Journal of Finance, 65 (2010), 179–216.Google Scholar
Bates, J., and Granger, C.. “The Combination of Forecasts.” Operational Research Quarterly, 20 (1969), 451–468.Google Scholar
Bollen, N. P., and Whaley, R. E.. “Hedge Fund Risk Dynamics: Implications for Performance Appraisal.” Journal of Finance, 64 (2009), 987–1037.CrossRefGoogle Scholar
Bossaerts, P., and Hillion, P.. “Implementing Statistical Criteria to Select Return Forecasting Models: What Do We Learn?” Review of Financial Studies, 12 (1999), 405–428.Google Scholar
Carhart, M. M. “On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 57–82.Google Scholar
Choi, D.; Getmansky, M.; Henderson, B.; and Tookes, H.. “Convertible Bond Arbitrageurs as Suppliers of Capital.” Review of Financial Studies, 23 (2010), 2492–2522.CrossRefGoogle Scholar
Christiansen, C.; Ranaldo, A.; and Söderlind, P.. “The Time-Varying Systematic Risk of Carry Trade Strategies.” Journal of Financial and Quantitative Analysis, 46 (2011), 1107–1125.Google Scholar
Christopherson, J. A.; Ferson, W.; and Glassman, D. A.. “Conditioning Manager Alphas on Economic Information: Another Look at the Persistence of Performance.” Review of Financial Studies, 11 (1998), 111–142.Google Scholar
Cochrane, J. H. “The Dog That Did Not Bark: A Defense of Return Predictability.” Review of Financial Studies, 21 (2008), 1533–1575.Google Scholar
Elton, E. J.; Gruber, M. J.; and Blake, C. R.. “The Persistence of Risk-Adjusted Mutual Fund Performance.” Journal of Business, 69 (1996), 133–157.Google Scholar
Fama, E. F., and French, K. R.. “Business Conditions and Expected Returns on Stocks and Bonds.” Journal of Financial Economics, 25 (1989), 23–49.Google Scholar
Ferson, W., and Qian, M.. “Conditional Performance Evaluation Revisited.” Research Foundation Monograph of the CFA Institute (2004).Google Scholar
Ferson, W.; Sarkissian, S.; and Simin, T.. “Spurious Regression in Financial Economics.” Journal of Finance, 58 (2003), 1393–1413.Google Scholar
Fung, W., and Hsieh, D. A.. “Hedge Fund Benchmarks: A Risk-Based Approach.” Financial Analysts Journal, 60 (2004), 65–80.Google Scholar
Ganshaw, T. Hedge Funds Humbled: The 7 Mistakes That Brought Hedge Funds to Their Knees and How They Will Rise Again. New York: McGraw-Hill (2010).Google Scholar
Getmansky, M.; Lo, A.; and Makarov, I.. “An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns.” Journal of Financial Economics, 74 (2004), 529–609.Google Scholar
Goyal, A., and Welch, I.. “A Comprehensive Look at the Empirical Performance of Equity Premium Prediction.” Review of Financial Studies, 21 (2008), 1455–1508.Google Scholar
Hendry, D. F., and Clements, M. P.. “Pooling of Forecasts.” Econometrics Journal, 7 (2004), 1–31.CrossRefGoogle Scholar
Jagannathan, R.; Malakhov, A.; and Novikov, D.. “Do Hot Hands Exist Among Hedge Fund Managers? An Empirical Evaluation.” Journal of Finance, 65 (2010), 217–255.Google Scholar
Jylhä, P., and Suominen, M.. “Speculative Capital and Currency Carry Trades.” Journal of Financial Economics, 99 (2011), 60–75.Google Scholar
Keim, D. B., and Stambaugh, R. F.. “Predicting Returns in the Stock and Bond Markets.” Journal of Financial Economics, 17 (1986), 357–390.Google Scholar
Kosowski, R.; Naik, N.; and Teo, M.. “Do Hedge Funds Deliver Alphas? A Bayesian and Bootstrap Analysis.” Journal of Financial Economics, 99 (2007), 229–264.Google Scholar
Lhabitant, F. S. Handbook of Hedge Funds. London: John Wiley & Sons (2006).Google Scholar
Lo, A. “The Statistics of the Sharpe Ratio.” Financial Analysts Journal, 58 (2002), 36–51.CrossRefGoogle Scholar
Mitchell, M., and Pulvino, T.. “Characteristics of Risk and Return in Risk Arbitrage.” Journal of Finance, 61 (2001), 2135–2175.CrossRefGoogle Scholar
Moskowitz, T. “Discussion of Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transaction Costs, and Expenses.” Journal of Finance, 55 (2000), 1695–1704.Google Scholar
Naik, N.; Ramadorai, T.; and Stromqvist, M.. “Capacity Constraints and Hedge Fund Strategy Returns.” European Financial Management, 13 (2007), 239–256.Google Scholar
Nelson, C. R., and Kim, M. J.. “Predictable Stock Returns: The Role of Small Sample Bias.” Journal of Finance, 48 (1993), 641–661.Google Scholar
Pástor, L., and Stambaugh, R. F.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642–685.Google Scholar
Patton, A., and Ramadorai, T.. “On the High-Frequency Dynamics of Hedge Fund Risk Exposures.” Journal of Finance, 68 (2013), 597–635.Google Scholar
Rapach, D. E.; Strauss, J. K.; and Zhou, G.. “Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy.” Review of Financial Studies, 23 (2010), 821–862.Google Scholar
Sadka, R. “Liquidity Risk and the Cross-Section of Hedge-Fund Returns.” Journal of Financial Economics, 98 (2010), 54–71.Google Scholar
Stambaugh, R. F. “Predictive Regressions.” Journal of Financial Economics, 54 (1999), 375–421.Google Scholar
Taylor, S. J.; Yadav, P. K.; and Zhang, Y.. “The Information Content of Implied Volatilities and Model-Free Volatility Expectations: Evidence from Options Written on Individual Stocks.” Journal of Banking and Finance, 34 (2010), 871–881.Google Scholar
Timmermann, A. “Forecast Combinations.” In Handbook of Economic Forecasting, Elliott, G., Granger, C. W. J., and Timmermann, A., eds. Amsterdam, The Netherlands: North-Holland (2006),135–196.Google Scholar
Timmermann, A. “Elusive Return Predictability.” International Journal of Forecasting, 24 (2008), 1–18.Google Scholar
Treynor, J. L., and Black, F.. “How to Use Security Analysis to Improve Portfolio Selection.” Journal of Business, 46 (1973), 66–86.Google Scholar