Risk measurement distortion: an improved model of return smoothing |
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Authors: | Jiaqi Chen Michael L Tindall Wenbo Wu |
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Institution: | 1.Twin Tree Capital Management,Dallas,USA;2.Banking Supervision Department,Federal Reserve Bank of Dallas,Dallas,USA;3.Department of Management Science and Statistics, College of Business,The University of Texas at San Antonio,San Antonio,USA |
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Abstract: | We examine the effects of smoothed hedge fund returns on standard deviation, skewness, and kurtosis of return and on correlation of returns using a MA(2)-GARCH(1,1)-skewed-t representation instead of the traditional MA(2) model employed in the literature. We present evidence that our proposed representation is more consistent with the behavior of hedge fund returns than the traditional MA(2) representation and that the traditional method tends to overstate the degree of smoothing observed in hedge fund returns. We examine methods for correcting the distortive effects of smoothing using our representation. |
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