Replicating Hedge Fund Indices with Optimization Heuristics

16 Pages Posted: 13 Jun 2010

See all articles by Manfred Gilli

Manfred Gilli

University of Geneva - Research Center for Statistics; Swiss Finance Institute

Enrico Schumann

Independent

Gerda Cabej

University of Geneva

Jonela Lula

University of Geneva

Multiple version iconThere are 2 versions of this paper

Date Written: June 8, 2010

Abstract

Hedge funds offer desirable risk-return profiles; but we also find high management fees, lack of transparency and worse, very limited liquidity (they are often closed to new investors and disinvestment fees can be prohibitive). This creates an incentive to replicate the attractive features of hedge funds using liquid assets. We investigate this replication problem using monthly data of CS Tremont for the period of 1999 to 2009. Our model uses historical observations and combines tracking accuracy, excess return, and portfolio correlation with the index and the market. Performance is evaluated considering empirical distributions of excess return, final wealth and correlations of the portfolio with the index and the market. The distributions are compiled from a set of portfolio trajectories computed by a resampling procedure. The nonconvex optimization problem arising from our model specification is solved with a heuristic optimization technique. Our preliminary results are encouraging as we can track the indices accurately and enhance performance (e.g. have lower correlation with equity markets).

Keywords: Hedge Funds, Hedge Fund Replication, Asset Allocation, Portfolio Optimization, Optimization Heuristics, Drawdown

JEL Classification: G11, C61, C63

Suggested Citation

Gilli, Manfred and Schumann, Enrico and Cabej, Gerda and Lula, Jonela, Replicating Hedge Fund Indices with Optimization Heuristics (June 8, 2010). Swiss Finance Institute Research Paper No. 10-22. Available at SSRN: https://ssrn.com/abstract=1623735 or http://dx.doi.org/10.2139/ssrn.1623735

Manfred Gilli (Contact Author)

University of Geneva - Research Center for Statistics ( email )

Geneva
Switzerland
+41223798222 (Phone)
+41223798299 (Fax)

HOME PAGE: http://www.unige.ch/ses/metri/gilli/

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Enrico Schumann

Independent ( email )

No Address Available

Gerda Cabej

University of Geneva ( email )

102 Bd Carl-Vogt
Genève, CH - 1205
Switzerland

Jonela Lula

University of Geneva ( email )

102 Bd Carl-Vogt
Genève, CH - 1205
Switzerland

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