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Alternative Market Briefing

EDHEC-Risk paper finds that hedge fund alpha is a form of fair reward

Monday, October 01, 2012

Beverly Chandler, Opalesque London: A new paper from the Newedge research chair on advanced modelling for alternative investments at EDHEC-Risk evaluates hedge fund performance through a new non linear risk adjustment of returns.

'Robust assessment of Hedge Fund Performance through Nonparametric Discounting’ by Caio Almeida and René Garcia prices exactly the usual set of risk factors considered in the hedge fund literature. The pair writes: "This nonlinear risk adjustment goes beyond the usual linear regression methodology used in many hedge fund performance papers, including nonlinear exposures based on option-like features."

The new approach proposed in this paper is designed to overcome two limitations of the linear methodology: it captures the nonlinear exposure of a hedge fund strategy to several risk factors, and it is not limited to nonlinear shapes resembling standard option payoff patterns. "We apply this methodology to various hedge fund indices as well as to individual hedge funds, considering a set of risk factors including equities, bonds, credit, currencies and commodities" the authors write.

The main result that emerges from their analysis is that exposure to higher-moment risks on the various factors matters. "Analysing the performance of HFRI indices on primary strategies and......................

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