scholarly journals Generating a Target Payoff Distribution with the Cheapest Dynamic Portfolio: An Application to Hedge Fund Replication

2010 ◽  
Author(s):  
Akihiko Takahashi ◽  
Kyo Yamamoto
Keyword(s):  
Hedge Fund ◽  
Hedge Fund Replication ◽  
Payoff Distribution ◽  
Dynamic Portfolio

scholarly journals Distributional Replication

Entropy ◽  
2021 ◽  
Vol 23 (8) ◽  
pp. 1063
Author(s):  
Brendan K. Beare
Keyword(s):  
Hedge Fund ◽  
Minimum Cost ◽  
Random Variable ◽  
Optimal Approximation ◽  
Regularity Conditions ◽  
Return Distribution ◽  
Continuous Random Variable ◽  
Hedge Fund Replication ◽  
Market Index ◽  
Fund Return

A function which transforms a continuous random variable such that it has a specified distribution is called a replicating function. We suppose that functions may be assigned a price, and study an optimization problem in which the cheapest approximation to a replicating function is sought. Under suitable regularity conditions, including a bound on the entropy of the set of candidate approximations, we show that the optimal approximation comes close to achieving distributional replication, and close to achieving the minimum cost among replicating functions. We discuss the relevance of our results to the financial literature on hedge fund replication; in this case, the optimal approximation corresponds to the cheapest portfolio of market index options which delivers the hedge fund return distribution.

Hedge Fund Replication

2017 ◽  
Author(s):  
Mikhail Tupitsyn ◽  
Paul Lajbcygier
Keyword(s):  
Hedge Funds ◽  
Direct Investment ◽  
Tracking Error ◽  
Hedge Fund ◽  
Cost Effective ◽  
Secondary Markets ◽  
Hedge Fund Replication ◽  
Effective Manner ◽  
Equity Indices ◽  
Hedge Fund Returns

In theory, analogous to equity indices, hedge fund indices can provide broad exposure to hedge funds in a cost-effective manner. In practice, however, hedge fund indices are difficult to implement because direct investment in hedge funds is impractical. Unlike equities, hedge funds are not traded on liquid secondary markets and are often closed to new investment. A solution is hedge fund replication, which, rather than require direct investment in hedge funds, synthetically recreates hedge fund index returns by investing in portfolios that are exposed to the same underlying economic factors that drive hedge fund returns. This approach provides broad, cost-effective, hedge fund exposure and avoids the practical problems associated with direct hedge fund investment. As a consequence, such hedge fund clones exhibit lower tracking error and substantially higher raw and risk-adjusted returns than both investible and noninvestible hedge fund indices.

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