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The Statistical Properties of Hedge Fund Index Returns and Their Implications for Investors

Harry M. Kat

Chris Brooks

University of Reading - ICMA Centre

October 31, 2001

Cass Business School Research Paper

The monthly return distributions of many hedge fund indices exhibit highly unusual skewness and kurtosis properties as well as first-order serial correlation. This has important consequences for investors. We demonstrate that although hedge fund indices are highly attractive in mean-variance terms, this is much less the case when skewness, kurtosis and autocorrelation are taken into account. Sharpe Ratios will substantially overestimate the true risk-return performance of (portfolios containing) hedge funds. Similarly, mean-variance portfolio analysis will over-allocate to hedge funds and overestimate the attainable benefits from including hedge funds in an investment portfolio. We also find substantial differences between indices that aim to cover the same type of strategy. Investors' perceptions of hedge fund performance and value added will therefore strongly depend on the indices used.

Number of Pages in PDF File: 42

Keywords: hedge fund, hedge fund index, Sharpe Ratio, Mean-Variance analysis, skewness, kurtosis

JEL Classification: G00

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Date posted: November 6, 2001  

Suggested Citation

Kat, Harry M. and Brooks, Chris, The Statistical Properties of Hedge Fund Index Returns and Their Implications for Investors (October 31, 2001). Cass Business School Research Paper. Available at SSRN: http://ssrn.com/abstract=289299 or http://dx.doi.org/10.2139/ssrn.289299

Contact Information

Chris Brooks
University of Reading - ICMA Centre ( email )
Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom
+44 118 931 82 39 (Phone)
+44 118 931 47 41 (Fax)
No contact information is available for Harry M. Kat
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