nep-fmk New Economics Papers
on Financial Markets
Issue of 2011‒04‒16
one paper chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Replicating Hedge Fund Indices with Optimization Heuristics By Manfred GILLI; Enrico SCHUMANN; Gerda CABEJ; Jonela LULA

  1. By: Manfred GILLI (University of Geneva and Swiss Finance Institute); Enrico SCHUMANN (University of Geneva); Gerda CABEJ (University of Geneva); Jonela LULA (University of Geneva)
    Abstract: Hedge funds offer desirable risk-return profiles; but we also find high management fees, lack of transparency and worse, very limited liquidity (they are often closed to new investors and disinvestment fees can be prohibitive). This creates an incentive to replicate the attractive features of hedge funds using liquid assets. We investigate this replication problem using monthly data of CS Tremont for the period of 1999 to 2009. Our model uses historical observations and combines tracking accuracy, excess return, and portfolio correlation with the index and the market. Performance is evaluated considering empirical distributions of excess return, final wealth and correlations of the portfolio with the index and the market. The distributions are compiled from a set of portfolio trajectories computed by a resampling procedure. The nonconvex optimization problem arising from our model specification is solved with a heuristic optimization technique. Our preliminary results are encouraging as we can track the indices accurately and enhance performance (e.g. have lower correlation with equity markets).
    Keywords: Hedge Funds, Hedge Fund Replication, Asset Allocation, Portfolio Optimization, Optimization Heuristics, Drawdown
    JEL: G11 C61 C63
    Date: 2010–06

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