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Annals of Operations Research

, Volume 266, Issue 1–2, pp 349–371 | Cite as

Tracking hedge funds returns using sparse clones

  • Margherita Giuzio
  • Kay Eichhorn-Schott
  • Sandra Paterlini
  • Vincent Weber
Analytical Models for Financial Modeling and Risk Management

Abstract

Whether hedge fund returns could be attributed to systematic risk exposures rather than managerial skills is an interesting debate among academics and practitioners. Academic literature suggests that hedge fund performance is mostly determined by alternative betas, which justifies the construction of investable hedge fund clones or replicators. Practitioners often claim that management skills are instrumental for successful performance. In this paper, we study the risk exposure of different hedge fund indices to a set of liquid asset class factors by means of style analysis. We extend the classical style analysis framework by including a penalty that allows to retain only relevant factors, dealing effectively with collinearity, and to capture the out-of-sample properties of hedge fund indices by closely mimicking their returns. In particular, we introduce a Log-penalty and discuss its statistical properties, showing then that Log-clones are able to closely track the returns of hedge fund indices with a smaller number of factors and lower turnover than the clones built from state-of-art methods.

Keywords

Style analysis Hedge fund replication Log-penalty regression LASSO Alternative betas 

Notes

Acknowledgements

We would like to thank the two anonymous referees and the Associate Editor for providing us with constructive comments that have improved the quality of our paper. Sandra Paterlini acknowledges financial support from CRoNos COST Action IC1408.

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Copyright information

© Springer Science+Business Media New York 2016

Authors and Affiliations

  • Margherita Giuzio
    • 1
  • Kay Eichhorn-Schott
    • 1
  • Sandra Paterlini
    • 1
  • Vincent Weber
    • 2
  1. 1.EBS Universität für Wirtschaft und RechtWiesbadenGermany
  2. 2.Prime Capital AGFrankfurtGermany

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