Optimal Portfolio Allocations with Hedge Funds
Boston University - Department of Finance & Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO)
Boston University School of Management - Finance and Economics Department; Center for Interuniversity Research and Analysis on Organization (CIRANO)
EDHEC Business School
October 22, 2010
Paris December 2010 Finance Meeting EUROFIDAI - AFFI
This paper analyzes optimal investment decisions, in the presence of non-redundant hedge funds, for investors with constant relative risk aversion. Factor regression models with optionlike risk factors and no-arbitrage principles are used to identify and estimate the market price of hedge fund risk, the volatility coefficients of hedge fund returns and the correlation between hedge fund and market returns. Timing ability causes stochastic fluctuations in these return characteristics. Outside investors optimally hold hedge funds for diversification purposes and are motivated to hedge fluctuations in return components caused by timing ability. The paper examines the portfolio structure and behavior and the impact of timing and selection abilities. Incorporating carefully selected hedge fund classes in asset allocation strategies can be a source of economic gains.
Number of Pages in PDF File: 64
Keywords: Asset Allocation, Hedge Funds, Performance Measurement, Market Timing, Market Price of Risk
JEL Classification: G11working papers series
Date posted: October 24, 2010
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