The Nature of Alpha
Arthur M. Berd
General Quantitative, LLC; The Journal of Investment Strategies
February 1, 2011
We suggest an empirical model of investment strategy returns which elucidates the importance of non-Gaussian features, such as time-varying volatility, asymmetry and fat tails, in explaining the level of expected returns. Estimating the model on the (former) Lehman Brothers Hedge Fund Index data, we demonstrate that the volatility compensation is a significant component of the expected returns for most strategy styles, suggesting that many of these strategies should be thought of as being 'short vol'. We present some fundamental and technical reasons why this should indeed be the case, and suggest explanation for exception cases exhibiting 'long vol' characteristics. We conclude by drawing some lessons for hedge fund portfolio construction.
Number of Pages in PDF File: 22
Keywords: hedge funds, performance attribution, expected returns, alpha, volatility, asymmetry, fat tails
JEL Classification: C22, C53, G11, G23working papers series
Date posted: December 6, 2011
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