Hedge Funds and Limits-to-Arbitrage: Does Financial Intermediaries’ Risk Predict Hedge Fund Returns?

2018 ◽  
Author(s):  
Adrien Becam
Keyword(s):  
Hedge Funds ◽  
Hedge Fund ◽  
Financial Intermediaries ◽  
Limits To Arbitrage ◽  
Hedge Fund Returns

Are hedge fund returns affected by media coverage of macroeconomic news?

2019 ◽  
Vol 36 (3) ◽  
pp. 427-439
Author(s):  
Sandip Dutta ◽  
James Thorson
Keyword(s):  
Hedge Funds ◽  
Media Coverage ◽  
Hedge Fund ◽  
Real Sector ◽  
Macroeconomic News ◽  
Content Type ◽  
Fund Managers ◽  
News Announcements ◽  
Hedge Fund Returns ◽  
The Impact

Purpose Extant literature suggests that the difficulty associated with the interpretation of macroeconomic news announcements by the market in general in different economic environments, might be the reason why most studies do not find any significant relationship between real-sector macroeconomic variables and financial asset returns. This paper aims to use a different approach to measure macroeconomic news. The objective is to examine if a different measure of a macroeconomic news variable, constructed from media coverage of the same, significantly affects hedge fund returns. Design/methodology/approach The authors use a news index for unemployment, which is a real-sector variable, constructed from newspaper coverage of unemployment announcements and examine its impact on hedge fund returns. Findings Contrary to the other studies that examine the impact of macroeconomic news on hedge fund returns, the authors find that media coverage of unemployment news announcements significantly affects hedge fund returns. Practical implications Overall, this paper demonstrates that the manner in which the market interprets macroeconomic news announcements in different economic environments is probably a more relevant factor for hedge funds and is more likely to impact hedge fund returns. In conjunction with variables – constructed from media coverage of unemployment news announcements – that factor in the manner of interpretation, it is found that surprises also matter for hedge fund returns. This is an important consideration for hedge fund managers as well. Originality/value To the best of the authors’ knowledge, this is the first study that examines the impact of media coverage of macroeconomic news announcements on hedge fund returns and finds significantly different results with real-sector macro variables.

MEASURING AND MONITORING THE EFFICIENCY OF MARKETS

2017 ◽  
Vol 20 (08) ◽  
pp. 1750051 ◽  
Author(s):  
DILIP B. MADAN ◽  
WIM SCHOUTENS ◽  
KING WANG
Keyword(s):  
Market Efficiency ◽  
Hedge Funds ◽  
Economic Activity ◽  
Hedge Fund ◽  
Exchange Traded Funds ◽  
Acceptability Index ◽  
Hedge Fund Returns

Market efficiency is measured by arbitrage proximity. The level of efficiency is calibrated by extent of a distortion of probability required to neutralize the drift. Simulations of bilateral gamma models estimated from past returns deliver for each asset on each day an empirical acceptability index. The assets covered include equities, commodities, currencies, volatility and hedge fund returns. It is observed that efficiency in equity is related to the process for up moves having more frequent and smaller jumps than its down side counterpart. For commodities the situation is reversed. Volatility indices trade more efficiently than equities, commodities, or currencies. Hedge fund returns reflect lower levels of efficiency supportive of hedge funds effectively exploiting market inefficiences. The relative inefficiency of the absence of trading is noted on comparing close to open with open to close returns. Small capitalization stocks trade more efficiently than the large ones. Sector exchange traded funds trade more efficiently than the S&P 500 index. Furthermore, economic activity reflected in greater high low spreads enhance market efficiency.

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.

Hedge Funds and Financial Misreporting

2021 ◽  
pp. 392-418
Author(s):  
Philippe Jorion
Keyword(s):  
Empirical Evidence ◽  
Hedge Funds ◽  
Hedge Fund ◽  
Compensation System ◽  
Good News ◽  
Regulatory Environment ◽  
Due Diligence ◽  
Financial Misreporting ◽  
Hedge Fund Returns

The growth of the hedge fund industry can be ascribed to its performance-based incentive compensation system as well as a lighter regulatory environment. These features, however, could also potentially create more opportunities for financial misreporting and even fraud. In response, recent research has attempted to detect misreporting by using due diligence information or by examining patterns in hedge fund returns. Empirical evidence suggests that hedge fund fraud can be usefully predicted from due diligence information, especially evidence of previous misrepresentation. Predicting misreporting from hedge fund returns, however, is much more difficult. This is because returns may reflect patterns in underlying assets instead of manager manipulation. For hedge fund investors, the good news is that the accumulated body of experience about detecting misreporting should help improve the quality of hedge fund investments. In addition, newly-imposed registration requirements for hedge fund advisors should also lower occurrences of misreporting.

scholarly journals Hedge Funds: Do They Do What They Say They Do?

2010 ◽  
Vol 8 (10) ◽  
Author(s):  
Scott P. Mackey ◽  
Michael R. Melton
Keyword(s):  
Hedge Funds ◽  
Hedge Fund ◽  
Strongly Correlated ◽  
Ample Evidence ◽  
Investment Style ◽  
Funds Of Hedge Funds ◽  
Standard Linear ◽  
Style Indices ◽  
Fund Investment ◽  
Hedge Fund Returns

<p class="MsoNoSpacing" style="text-align: justify; margin: 0in 0.5in 0pt; mso-pagination: none;"><span style="color: black; font-size: 10pt; mso-themecolor: text1;"><span style="font-family: Times New Roman;">The purpose of this research is two-fold, to determine if hedge funds follow their stated strategy styles and to examine how hedge funds&rsquo; strategy allocations evolve over time in response to changed economic and market conditions.<span style="mso-spacerun: yes;">&nbsp; </span>Our key advance is that we show that standard linear style models like that of Sharpe (1992) can be applied to hedge fund returns as long as the returns of the style indices in the model themselves display the nonlinear option-like characteristics of hedge fund returns.<span style="mso-spacerun: yes;">&nbsp; </span>For our research, the returns of our sample of Funds of Hedge Funds are strongly correlated to the returns of portfolios of hedge fund investment style indices. <span style="mso-spacerun: yes;">&nbsp;</span>In this way, we capture the spirit of Fung &amp; Hsieh's (2002) Asset-Based Style Factors for Hedge Funds.<span style="mso-spacerun: yes;">&nbsp; </span>Based on our results, it appears that the answer to the first question is &ldquo;somewhat&rdquo;, while we find ample evidence of significant shifts in allocation among the Fund of Hedge Funds from the first sample period (1997-2001) to the second (2002-2006).<span style="mso-spacerun: yes;">&nbsp; </span>The changes in allocation appear to rationally reflect the changed economic conditions and investment opportunities existing at the time.</span></span></p>

Flagging potential fraudulent investment activity

2016 ◽  
Vol 23 (4) ◽  
pp. 882-901
Author(s):  
Jeremy King ◽  
Gary Wayne van Vuuren
Keyword(s):  
Hedge Funds ◽  
Hedge Fund ◽  
Sharpe Ratio ◽  
Financial Fraud ◽  
Investment Activity ◽  
Content Type ◽  
Limited Success ◽  
Bias Ratio ◽  
Return Distributions ◽  
Hedge Fund Returns

Purpose This paper aims to investigate the use of the bias ratio as a possible early indicator of financial fraud – specifically in the reporting of hedge fund returns. In the wake of the 2008-2009 financial crisis, numerous hedge funds were liquidated and several cases of financial fraud exposed. Design/methodology/approach Risk-adjusted return metrics such as the Sharpe ratio and Value at Risk were used to raise suspicion for fraud. These metrics, however, assume distributional normality and thus have had limited success with hedge fund returns (a characteristic of which is highly skewed, non-normal return distributions). Findings Results indicate that potential fraud would have been detected in the early stages of the scheme’s life. Having demonstrated the credibility of the bias ratio, it was then applied to several indices and (anonymous) South African hedge funds. The results were used to demonstrate the ratio’s scope and robustness and draw attention to other metrics which could be used in conjunction with it. Results from these multiple sources could be used to justify further investigation. Research limitations/implications The traditional metrics for performance evaluation (such as the Sharpe ratio), assume distributional normality and thus have had limited success with hedge fund returns (a characteristic of which is highly skewed, non-normal return distributions). The bias ratio, which does not rely on normally distributed returns, was applied to a known fraud case (Madoff’s Ponzi scheme). Practical implications The effectiveness of the bias ratio in demonstrating potential suspicious financial activity has been demonstrated. Originality/value The financial market has come under heightened scrutiny in the past decade (2005 – 2015) as a result of the fragile and uncertain economic milieu that still (2015) persists. Numerous risk and return measures have been used to evaluate hedge funds’ risk-adjusted performance, but many fail to account for non-normal return distributions exhibited by hedge funds. The bias ratio, however, has been demonstrated to effectively flag potentially fraudulent funds.

Benchmarking and Bias in Hedge Funds

2017 ◽  
Author(s):  
Jeffrey S. Smith ◽  
Kenneth Small ◽  
Phillip Njoroge
Keyword(s):  
Selection Bias ◽  
Hedge Funds ◽  
Hedge Fund ◽  
Academic Research ◽  
Fund Performance ◽  
Measurement Bias ◽  
Return Smoothing ◽  
Survivorship Bias ◽  
Hedge Fund Returns ◽  
Hedge Fund Performance

This chapter discusses investment benchmarking and measurement bias in hedge fund performance. A good benchmark should be unambiguous, investible, measurable, appropriate, reflective of current investment opinions, specified in advance, and accountable. Additionally, a good benchmark should be simple, easily replicable, comparable, and representative of the market that the benchmark is trying to capture. Several biases, such as database selection bias, survivorship bias, style classification bias, backfill bias, self-reporting bias, and return-smoothing bias exist that impede the process of creating a benchmark. These biases increase the difficulty of studying hedge fund returns and managerial skill. However, most of the academic research on hedge fund returns report positive alphas for hedge funds.

Investor behavior: hedge fund returns and strategies

2017 ◽  
Vol 9 (1) ◽  
pp. 14-42 ◽  
Author(s):  
Andres Bello ◽  
Jan Smolarski ◽  
Gökçe Soydemir ◽  
Linda Acevedo
Keyword(s):  
Hedge Funds ◽  
Hedge Fund ◽  
Management Style ◽  
Active Management ◽  
Warning Sign ◽  
Content Type ◽  
Market Sentiment ◽  
Irrational Behavior ◽  
Market Fundamentals ◽  
Hedge Fund Returns

Purpose The purpose of this paper is to investigate to what extent hedge funds are subject to irrationality in their investment decisions. The authors advance the hypothesis that irrational behavior affects hedge fund returns despite their sophistication and active management style. Design/methodology/approach The irrational component may follow a pattern consistent with the observed hedge fund returns yet far distant from market fundamentals. The authors include factors beyond the original version of capital asset pricing model such as Fama and French and Carhart models, as well as less stringent models, such as APT and Fung and Hsieh, to test whether these models are able to capture the irrational nature of the residuals. Findings After finding that institutional irrational sentiments play a role in hedge fund returns, we note that the returns are not completely shielded against irrational trading; however, hedge fund returns appear to be affected only by the irrational component derived from institutional trading rather than that emanated from individuals. Research limitations/implications Different sources of irrationality may have asymmetric effects on hedge fund returns. Using a different set of sophisticated investors along with different market sentiment proxies may yield different results. Practical implications The authors argue that investors can use irrational beta to gauge the extent of institutional irrational sentiments prevailing in markets for the purpose of re-adjusting their portfolios and therefore use the betas as an early warning sign. It can also guide investors in avoiding funds and strategies that display greater irrational behavior. Originality/value The study advance the idea that the unexpected, hereafter irrational, component may follow a pattern consistent with the observed hedge fund returns, yet different from market fundamentals.

scholarly journals Hedge Fund Treasury Trading and Funding Fragility: Evidence from the COVID-19 Crisis

2021 ◽  
Vol 2021 (037) ◽  
pp. 1-68
Author(s):  
Mathias S. Kruttli ◽  
◽  
Phillip J. Monin ◽  
Lubomir Petrasek ◽  
Sumudu W. Watugala ◽  
...  
Keyword(s):  
Hedge Funds ◽  
Hedge Fund ◽  
Cash Holdings ◽  
Liquidity Management ◽  
Regulatory Constraints ◽  
Relative Value ◽  
Share Restrictions ◽  
Arbitrage Trading ◽  
Hedge Fund Returns

Hedge fund gross U.S. Treasury (UST) exposures doubled from 2018 to February 2020 to $2.4 trillion, primarily driven by relative value arbitrage trading and supported by corresponding increases in repo borrowing. In March 2020, amid unprecedented UST market turmoil, the average UST trading hedge fund had a return of -7% and reduced its UST exposure by close to 20%, despite relatively unchanged bilateral repo volumes and haircuts. Analyzing hedge fund-creditor borrowing data, we find the large, more regulated dealers provided disproportionately more funding during the crisis than other creditors. Overall, the step back in hedge fund UST activity was primarily driven by fund-specific liquidity management rather than dealer regulatory constraints. Hedge funds exited the turmoil with 20% higher cash holdings and smaller, more liquid portfolios, despite low contemporaneous outflows. This precautionary flight to cash was more pronounced among funds exposed to greater redemption risk through shorter share restrictions. Hedge funds predominantly trading the cash-futures basis faced greater margin pressure and reduced UST exposures and repo borrowing the most. After the market turmoil subsided following Fed intervention, hedge fund returns recovered quickly, but UST exposures did not revert to pre-shock levels over the subsequent months.

scholarly journals Are higher-order factors useful in pricing the cross-section of hedge fund returns?

2019 ◽  
Vol 17 (2) ◽  
pp. 1
Author(s):  
Caio Almeida ◽  
Elaine Fang
Keyword(s):  
Risk Factors ◽  
Linear Model ◽  
Hedge Funds ◽  
Hedge Fund ◽  
Second Order ◽  
Lasso Regression ◽  
Step Method ◽  
Cross Sectional ◽  
Interaction Terms ◽  
Hedge Fund Returns

This paper investigates hedge funds’ exposures to various risk factors across different investment strategies through models with both linear and second-order factors. Despite many efforts to search for the set of risk factors that best explains cross-sectional hedge fund returns, no consensus has been reached. In this study, we extend the analysis from an augmented linear model based on Fama and French (1993) and Fung and Hsieh (2001) to second-order models that include all quadratic and interaction terms by adopting a novel multistep strategy that combines the variable selection capabilities of the lasso regression with the Fama-MacBeth (1973) two-step method. We find that several quadratic and interaction terms are statistically significant for some strategies; however, there is no evidence that the second-order models have more overall explanatory or predictive power than the linear model. Moreover, while both the linear and second-order models perform well for directional funds, missing factors may still remain for semidirectional funds.

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