Abstract
In this paper, we propose a new benchmarking procedure lying on cumulants for computing the factor loadings in financial models of returns. We apply this technique to the well-known augmented Fama and French (J Fin Econ 43(2):153–193, 1997) model and compare it with another technique of ours based on higher moments. Our new procedure confirms the fact that the alpha is supposed to decrease when we disaggregate HFR indices to the level of individual funds while correcting for specification errors. Our new technique is therefore useful for hedge funds selection or ranking based on the alpha of Jensen corrected for specification errors. This technique will also be useful for calibrating other financial models of returns like the simple market model or the conditional alpha and beta models.
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Notes
Other possible causes are: the omission of relevant variables, the aggregation level of the data or simply an incorrect functional form.
The address of the French’s website is: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.
A short put option carries the risk of rare but large losses. Applied to hedge fund, that means that the distribution of their returns has a left fat tail.
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Acknowledgements
We would like to thank the participants of the 64th International Atlantic Economic Conference held in Savannah, Georgia in October 2007. We would also like to thank Professor Jose Maria Montero Lorenzo, organizer of the econometric and statistical methods session, Professor Jean-Pierre Lévy-Mangin, chairman of this session, and an anonymous referee for their helpful comments.
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François-Éric Racicot is an associate researcher with Chaire d’information financière et organisationnelle at ESG-UQAM, and permanent member of Laboratory for Research in Statistics and Probability (LRSP). Raymond Théoret an associate researcher with Chaire d’information financière et organisationnelle at ESG-UQAM.
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Racicot, FÉ., Théoret, R. On Optimal Instrumental Variables Generators, with an Application to Hedge Fund Returns. Int Adv Econ Res 15, 30–43 (2009). https://doi.org/10.1007/s11294-008-9179-2
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DOI: https://doi.org/10.1007/s11294-008-9179-2
Keywords
- Hedge funds returns
- Alpha of Jensen
- Financial models
- Cumulants
- Higher moments
- Specification errors
- Aggregation bias