Insight – Distributional Hedge Fund Replication Via State Contingent Stochastic Dominance

Abstract:     
We propose a new hybrid hedge fund replication technique, which combines aspects of portfolio construction from factor based replication with an innovative version of distributional replication. It uses a parameterized replicating strategy for which we match a version of state contingent integral stochastic dominance. The dominance will be over a set of distributions reflecting preferred, state contingent distributional performance characteristics, granting insight into return features to arbitrary fine detail. It emphasizes the replication of desired aspects rather than the replication of the performance path. A further application of this approach is to replicate certain features of a target fund and at the same time dominate on less desired aspect. Before the new approach to replication is presented, a brief recollection of the evolution, the various different approaches and some of the pitfalls of hedge fund replication are highlighted.

Number of Pages in PDF File: 15

Keywords: hedge fund, replication technique, portfolio construction, stochastic dominance

working papers series