Persistence Analysis of Hedge Fund Returns

Abstract

We use a Markov chain model to evaluate pure persistence in hedge fund returns. We study two forms of pure persistence: absolute persistence and persistence with respect to the high water mark, accounting for the size of drawdowns. We find that hedge funds in general exhibit persistence in positive returns, but not necessarily persistence in negative returns. We develop a new approach to account for serial correlation based on the method of moments and the model of Getmansky, Lo and Makarov (2004). Our approach overcomes the issue of discontinuity in the return distribution around zero identified by Bollen and Pool (2009).

Keywords: Hedge funds, Markov chain, smoothed returns, persistence, high water mark

JEL Classification: C13, G11, G23