Who Needs Hedge Funds? A Copula-Based Approach to Hedge Fund Return Replication
Harry M. Kat
City University London - Sir John Cass Business School
Helder P. Palaro
November 23, 2005
Alternative Investment Research Centre Working Paper No. 27
Cass Business School Research Paper
In this paper we develop and demonstrate the workings of a copula-based technique that allows the derivation of dynamic trading strategies, which generate returns with statistical properties similar to hedge funds. We show that this technique is not only capable of replicating fund of funds returns, but is equally well suited for the replication of individual hedge fund returns. Since replication is accomplished by trading futures on traditional assets only, it avoids the usual drawbacks surrounding hedge fund investments, including the need for extensive due diligence, liquidity, capacity, transparency and style drift problems, as well as excessive management fees. As such, our synthetic hedge fund returns are clearly to be preferred over real hedge fund returns.
Number of Pages in PDF File: 52
Keywords: hedge fund, replication, copula, dynamic trading
JEL Classification: G10, G23
Date posted: November 30, 2005
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