Regular(Ized) Hedge Fund Clones

34 Pages Posted: 8 May 2010

See all articles by Daniel Giamouridis

Daniel Giamouridis

Bank of America - Bank of America Merrill Lynch; Athens University of Economics and Business; City University London - Cass Business School - Faculty of Finance; EDHEC Risk Institute

Sandra Paterlini

University of Trento - Department of Economics and Management

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Date Written: January 13, 2009

Abstract

This article addresses the problem of portfolio construction in the context of efficient hedge fund investments replication. We propose a modification to the standard à la Sharpe ‘style analysis’ where we augment the objective function with a penalty proportional to the sum of the absolute values of the replicating asset weights, i.e. the norm of the asset weights vector. This penalty regularizes the optimization problem, with significant impacts on the stability of the resulting asset mix and the risk and return characteristics of the replicating portfolio. Our results suggest that the norm-constrained replicating portfolios exhibit significant correlations with their benchmarks, often higher than 0.9, have a fraction, i.e. about 1/2 to 2/3, of active positions relative to those determined through the standard method, and are obtained with turnover which is in some instances about 1/4 of that for the standard method. Moreover, the extreme risk of the replicating portfolios obtained through the regularization method is always lower than that exhibited by currently available commercial hedge fund investment replication products.

Suggested Citation

Giamouridis, Daniel and Paterlini, Sandra, Regular(Ized) Hedge Fund Clones (January 13, 2009). CAREFIN Research Paper No. 1/09. Available at SSRN: https://ssrn.com/abstract=1600539

Daniel Giamouridis (Contact Author)

Bank of America - Bank of America Merrill Lynch ( email )

United Kingdom

Athens University of Economics and Business ( email )

Department of Accounting and Finance
Greece

City University London - Cass Business School - Faculty of Finance ( email )

London, EC2Y 8HB
Great Britain

EDHEC Risk Institute ( email )

Lille
France

Sandra Paterlini

University of Trento - Department of Economics and Management ( email )

Via Inama 5
Trento, I-38100
Italy

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