On Optimal Instrumental Variables Generators, with an Application to Hedge Fund Returns |
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| Authors: | François-Éric Racicot Raymond Théoret |
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| Institution: | (1) Department of Administrative Sciences, University of Quebec—Outaouais, UQO, 101 St-Jean-Bosco Street, Lucien Brault Building, Gatineau (Hull), QC, Canada, J8X 3X7;(2) Department of Finance, University of Quebec—Montreal, UQAM, 315 Ste-Catherine East, Montreal, QC, Canada, H3X 2X2 |
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| Abstract: | In this paper, we propose a new benchmarking procedure lying on cumulants for computing the factor loadings in financial models
of returns. We apply this technique to the well-known augmented Fama and French (J Fin Econ 43(2):153–193, 1997) model and compare it with another technique of ours based on higher moments. Our new procedure confirms the fact that the
alpha is supposed to decrease when we disaggregate HFR indices to the level of individual funds while correcting for specification
errors. Our new technique is therefore useful for hedge funds selection or ranking based on the alpha of Jensen corrected
for specification errors. This technique will also be useful for calibrating other financial models of returns like the simple
market model or the conditional alpha and beta models.
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| Keywords: | Hedge funds returns Alpha of Jensen Financial models Cumulants Higher moments Specification errors Aggregation bias |
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