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Frontiers of Engineering Management

Front. Eng    2020, Vol. 7 Issue (2) : 275-286
Option-like properties in the distribution of hedge fund returns
Katharina DENK1, Ben DJERROUD2(), Luis SECO3, Mohammad SHAKOURIFAR4, Rudi ZAGST1
1. Mathematical Finance, Technical University of Munich, Munich D-80333, Germany
2. Portfolio Analytics & Management, Sigma Analysis & Management Ltd., Toronto, ON M5G1M1, Canada
3. Department of Mathematics, University of Toronto, Toronto, ON M5S1A1, Canada
4. Investments & Risk Analytics, Sigma Analysis & Management Ltd., Toronto, ON M5G1M1, Canada
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Hedge funds have recently become popular because of their low correlation with traditional investments and their ability to generate positive returns with a relatively low volatility. However, a close look at those high-performing hedge funds raises the questions on whether their performance is truly superior and whether the high management fees are justified. Incurring no alpha costs, passive hedge fund replication strategies raise the question on whether they can similarly perform by improving efficiency at reduced costs. Therefore, this study investigates two different model approaches for the equity long/short strategy, where weighted segmented linear regression models are employed and combined with two-state Markov switching models. The main finding proves a short put option structure, i.e., short equity market volatility, with the put structure present in all market states. We obtain an evidence that the hedge fund managers decrease their short-volatility profile during turbulent markets.

Keywords hedge funds      hedge fund index      segmented linear regression models      regime-switching models      mimicking portfolios      single factor-based hedge fund replication      equity long–short strategy     
Corresponding Authors: Ben DJERROUD   
Just Accepted Date: 19 January 2020   Online First Date: 24 March 2020    Issue Date: 27 May 2020
 Cite this article:   
Katharina DENK,Ben DJERROUD,Luis SECO, et al. Option-like properties in the distribution of hedge fund returns[J]. Front. Eng, 2020, 7(2): 275-286.
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Katharina DENK
Fig.1  Excess returns of S&P500 from 04/01/2003 to 04/30/2013.
Fig.2  HFRX Equity Hedge Index: Total market.
Fig.3  HFRX Equity Hedge Index: Calm market.
Fig.4  HFRX Equity Hedge Index: Turbulent market.
M1 M2(0) (turbulent) M2(1) (calm)
β1,0[%] 0.00 0.04 −0.01
β1,1[%] 0.29 0.27 0.30
β2,0[%] 0.44 0.35 0.78
β2,1[%] 0.01 0.06 −0.21
α1[%] 1.53 1.53 1.53
RSS 0.0000 0.0119 0.0076
R2[%] 42.14 46.58 47.60
Tab.1  HFRX Equity Hedge Index
M1 M2 (turbulent) M2 (calm)
wP[%] 28.30 20.78 51.63
wI[%] 0.88 6.40 −21.50
wB[%] 70.82 72.83 69.87
Tab.2  Weights of the mimicking portfolio for the HFRX Equity Hedge Index
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