Performance evaluation of hedge funds with option-based and buy-and-hold strategies
Subject
Finance
Publishing details
Authors / Editors
Agarwal V; Naik N Y
Biographies
Publication Year
2001
Abstract
Since hedge fund returns exhibit non-linear option-like exposures to standard asset classes (Fung and Hsieh (1997a, 2000a)), traditional linear factor models offer limited help in evaluating the performance of hedge funds. We propose a general asset class factor model comprising of excess returns on passive option-based strategies and on buy-and-hold strategies to benchmark the performance of hedge funds. Although, in practice, hedge funds can follow a myriad of dynamic trading strategies, we find that a few simple option writing/buying strategies are able to explain a significant proportion of variation in the hedge fund returns over time. Overall, we find that only 35% of the hedge funds have added significant value in excess of monthly survivorship bias of 0.30% as estimated by Fung and Hsieh (2000b). Their performance has been varying over time - 38% of the funds added value in the early nineties compared to 28% in the late nineties. When we compare the averages and the distributions of alphas and information ratios of funds that use leverage with those that do not, we find that the two are statistically indistinguishable in an overwhelming majority of the cases.
Publication Research Centre
Hedge Fund Centre
Series Number
HF-003
Series
Centre for Hedge Fund Research and Education Working Paper