An Alternative Approach to Alternative Beta
Université d'Évry - Centre D'Etudes des Politiques Economiques et de L'Emploi (EPEE); Lyxor Asset Management
April 1, 2007
Hedge fund replication based on factor models is encountering growing interest. In this paper, we investigate the implications of substituting standard rolling windows regressions, which appear ad-hoc, with more efficient methodologies like the Kalman Filter. We show that the copycats constructed this way offer risk-return profiles which share several characteristics with the ones posted by hedge funds indices: Sharpe ratios above buy-and-hold strategies on standard assets, moderate correlation with standard assets and limited drawdowns during equity downward trends. An interesting result is that the shortfall risk seems less important than with hedge fund indices and regressions based-trackers. We finally propose new breakdowns of hedge fund performance into alpha, traditional beta and alternative beta.
Number of Pages in PDF File: 17
Keywords: Hedge funds, factor models, beta, alpha, replication, Kalman filter
JEL Classification: G00
Date posted: November 30, 2007