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Evaluating Hedge Fund Performance when Models are Misspecified

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1702
Author
David Ardia Laurent Barras Patrick Gagliardini O. Scaillet
Category
Financial
Date Posted
2020/09/18
Date Retrieved
2022/06/16
Date Revised
2022/06/16
Date Written
2021/06/02
Description
Evaluating the performance of hedge funds is challenging because any benchmark model is unlikely to capture their numerous strategies. To assess the impact of model misspecification we develop a novel approach to formally compare hedge fund models. This comparison sharpens performance evaluation by improving the separation between pure alphas and factor exposures. We find that the standard models deliver the same performance as the simplest benchmark—the CAPM. In contrast a parsimonious model based on economically motivated factors (including carry time-series momentum and variance) tracks alternative hedge fund strategies and achieves a sizable performance reduction relative to the CAPM.
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JEL Classifications
G11 G12 C14 C33 C58
Keywords
Hedge fund performance alternative strategies misspecification model comparison
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