Polynomial Goal Programming and the Implicit Higher Moment Preferences of U.S. Institutional Investors in Hedge Funds

47 Pages Posted: 19 Mar 2009

See all articles by Denis Schweizer

Denis Schweizer

Concordia University

Juliane Proelss

Concordia University, Quebec; Trier University of Applied Sciences

Multiple version iconThere are 2 versions of this paper

Date Written: March 15, 2009

Abstract

Polynomial goal programming (PGP) has been successfully introduced in the hedge fund allocation literature. The method is intuitive, and flexible enough to incorporate investor preferences in higher moments of the return distribution. However, until now, PGP could not be used to its full effectiveness because it requires quantification of "real" preference parameters toward those moments. Previously, those parameters were chosen without elaborate research. Our goal in this paper is to identify implied sets of preference parameters by using investors' choice of and the importance they attribute to risk and performance measures. We use three groups of institutional investors, pension funds, insurance companies, and endowments, and we derive implied sets of preference parameters in the context of a hedge fund portfolio optimization. To extract implied investor preference parameters, we determine optimal hedge fund portfolios according to the criteria set by those fund of hedge fund sponsors. We then fit implied preference parameters so that the PGP optimal portfolio is identical to the desired hedge fund portfolio. We can thus determine "real" preferences for the higher moments of the portfolio return distribution. With the obtained economically justified sets of preference parameters, we can use the well established PGP framework more efficiently to derive allocations that satisfy institutional investor expectations for hedge fund investments. Furthermore, the implied preference parameters enable fund of hedge fund managers and other managers to combine different hedge fund strategies optimally according to investor expectations. Finally, we can assess the importance of individual moments, as well as their marginal rates of substitution.

Keywords: Polynomial Goal Programming, Fund of Hedge Funds, Higher Moments, Investor Preferences

JEL Classification: G11, G23

Suggested Citation

Schweizer, Denis and Proelss, Juliane, Polynomial Goal Programming and the Implicit Higher Moment Preferences of U.S. Institutional Investors in Hedge Funds (March 15, 2009). Available at SSRN: https://ssrn.com/abstract=1360248 or http://dx.doi.org/10.2139/ssrn.1360248

Denis Schweizer

Concordia University ( email )

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HOME PAGE: http://www.concordia.ca/jmsb/faculty/denis-schweizer.html

Juliane Proelss (Contact Author)

Concordia University, Quebec ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1MB
Canada

Trier University of Applied Sciences ( email )

Scheidershof
Trier, 54293
Germany

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