Hedge fund strategies,performance &diversification: A portfolio theory & stochastic discount factor approach |
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| Affiliation: | 1. School of Management, University of Bath, Claverton Down, Bath, BA2 7AY, UK;2. York Management School, University of York, York, YO10 5GD, UK;3. ICMA Centre, Henley Business School, University of Reading, PO Box 242, Reading, RG6 6BA, UK;4. Management School, University of Liverpool, Chatham Street, Liverpool, L69 7ZH, UK;1. University of Wollongong, Australia;2. University of Sydney, Australia;1. Queen Mary, University of London, School of Business and Management, Francis Bancroft Building, Mile End Road, London, E1 4NS, United Kingdom;2. The Open University Business School, Department for Accounting & Finance, Walton Hall, Milton Keynes, MK7 6AA, United Kingdom;1. Kent Business School – University of Kent, Park Wood Rd, Canterbury, CT2 7FS, UK;2. School of Accounting – RMIT University, 445, Swanston Street, 3000, VIC, Australia;3. Department of Economics and Management, University of Pisa, Via Cosimo Ridolfi, 10, 56124, Pisa, Italy;1. Aarhus University, Aarhus, Denmark;2. Scuola Superiore Sant’ Anna, Pisa, Italy;1. Department of Management & Innovation Systems, University of Salerno, Italy;2. Department of Business and Economics, Parthenope University of Naples, Italy;3. Department of Accounting, Aston Business School, Aston University, Birmingham, UK;4. Department of Economics and Management, University of Pisa, Italy |
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| Abstract: | ![]()
For 5500 North American hedge funds following 11 different strategies, we analyse the stand-alone performance of these strategies using a stochastic discount factor approach. Employing the same data, we then consider the diversification benefits of each hedge fund strategy when combined with a portfolio of US equities and bonds. We compute the out-of-sample Black-Litterman portfolios, with Bayes-Stein, higher moments, simulations, desmoothed data and allowance for regimes as robustness checks. All but two hedge fund strategies out-perform the market as stand-alone investments; and all but one provide significant diversification benefits. The higher is an investor’s risk aversion, the more beneficial is diversification into hedge funds. |
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| Keywords: | Hedge funds Portfolio diversification Black-Litterman Bayes-Stein Stochastic discount factors G11 |
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