Sun, Apr 26, 2015
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
New Managers May 2013

Peter Urbani' Statistics - Ignoring serial auto-correlation may understate hedge fund volatility by more than 30%

In a recent paper, Marcos Lopez de Prado of Hess Energy Trading Company and David H. Bailey of Lawrence Berkeley National Laboratory, derive closed form approximations for Expected Maximum Drawdown (MaxDD). They also derive formulae for the expected time to reach the Maximum Drawdown (t*) and the expected Maximum Time Under Water (MaxTuW), which under the assumption of IID Normality turns out to be three times the time taken to reach the maximum drawdown. Bailey and de Prado show that this ‘Triple Penance Rule' holds independently of the Sharpe Ratio.

This has important consequences for people who may be using some combination of drawdown and Sharpe Ratio to stop out loss-making funds.

Moreover, Bailey and de Prado show that under the more general case, when first-order serial-auto-correlation is accounted for, the Triple Penance rule may no longer apply as the higher volatility of positively serial auto correlated funds may enable them to recover faster than 3 x the length of time it took the drawdown to occur.

They state,” We provide a theoretical justification to why investment firms typically set less strict stop-out rules to portfolio managers with higher Sharpe ratios, despite the fact that they should be expected to deliver superior performance. We generalize this framework to the case

of first-order auto-correlated investment outcomes, and conclude that ignoring the effect of serial correlation leads to a gross underestimation of the downside potential of hedge fund strategies, by as much as 70%. We also estimate that some hedge funds may be firing more than three times the number of skilful portfolio mana......................

To view our full article please login

This article was published in Opalesque's New Managers a top-down monthly analysis, news and research publication on the global emerging manager space.
New Managers
New Managers
New Managers

Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing


  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. U.S. does not want hedge funds to invest in offshore re-insurers for tax purposes[more]

    Komfie Manalo, Opalesque Asia: The U.S. Treasury Department on Thursday introduced a new rule aimed at limiting hedge funds’ ability to reduce their tax bills by investing in insurance companies in offshore tax havens. As a general rule, the U.S. tax laws does not allow hedge funds to use off

  2. Ruling: Hedge funds suing Argentina can have access to bond offering details[more]

    Komfie Manalo, Opalesque Asia: U.S. District Judge Thomas Griesa in Manhattan ruled yesterday that hedge funds are entitled to details of a recent bond offering by Buenos Aires, reports

  3. Fund managers express concern of overvaluation in both equity and bond markets[more]

    Komfie Manalo, Opalesque Asia: According to the BofA Merrill Lynch Fund Manager Survey, investors see growing overvaluations in both

  4. Update: Wall Street has strong feelings about Jon Corzine trying to make a comeback[more]

    From Businessinsider.com.au: Former New Jersey Governor Jon Corzine is thinking about starting his own hedge fund, according to the Wall Street Journal, and because of the way his last firm imploded, Wall Street has strong feelings about that. “Truth is the larger seeders would never give him money

  5. Opalesque Exclusive: Cybersecurity and hedge funds - A manager’s experience, Part Four[more]

    Benedicte Gravrand, Opalesque Geneva: Ruane, Cunniff and Goldfarb, Inc. used to have their own IT infrastructure. Todd Ruoff, Executive Vice President in charge of trading, operations and technology, was responsible for its maintenance. Then he started looking at outsourced providers a couple of

 

banner