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Optimal Portfolio Allocations with Hedge FundsJerome DetempleBoston University - Department of Finance & Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO) Marcel RindisbacherBoston University School of Management - Finance and Economics Department; Center for Interuniversity Research and Analysis on Organization (CIRANO) René GarciaEDHEC Business School October 22, 2010 Paris December 2010 Finance Meeting EUROFIDAI - AFFI Abstract: 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: G11 working papers seriesDate posted: October 24, 2010Suggested CitationContact Information
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