Optimal Portfolio Allocations with Hedge Funds

64 Pages Posted: 24 Oct 2010

See all articles by Jerome Detemple

Jerome Detemple

Boston University - Department of Finance & Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO)

Marcel Rindisbacher

Questrom School of Business, Boston University; Center for Interuniversity Research and Analysis on Organization (CIRANO)

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques; University of Montreal

Date Written: October 22, 2010

Abstract

This paper analyzes optimal investment decisions, in the presence of non-redundant hedge funds, for investors with constant relative risk aversion. Factor regression models with optionlike risk factors and no-arbitrage principles are used to identify and estimate the market price of hedge fund risk, the volatility coefficients of hedge fund returns and the correlation between hedge fund and market returns. Timing ability causes stochastic fluctuations in these return characteristics. Outside investors optimally hold hedge funds for diversification purposes and are motivated to hedge fluctuations in return components caused by timing ability. The paper examines the portfolio structure and behavior and the impact of timing and selection abilities. Incorporating carefully selected hedge fund classes in asset allocation strategies can be a source of economic gains.

Keywords: Asset Allocation, Hedge Funds, Performance Measurement, Market Timing, Market Price of Risk

JEL Classification: G11

Suggested Citation

Detemple, Jerome and Rindisbacher, Marcel and Garcia, René, Optimal Portfolio Allocations with Hedge Funds (October 22, 2010). Paris December 2010 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=1695866 or http://dx.doi.org/10.2139/ssrn.1695866

Jerome Detemple (Contact Author)

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
(617) 353-4297 (Phone)
(617) 353 6667 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO)

2020 rue University, 25th Floor
Montreal, Quebec H3C 3J7
Canada

Marcel Rindisbacher

Questrom School of Business, Boston University ( email )

595 Commonwealth Avenue
Boston, MA MA 02215
United States
617 353 4152 (Phone)
617 353 999 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

2020 rue University, 25th Floor
Montreal, Quebec H3C 3J7
Canada

René Garcia

Université de Montréal - CIREQ - Département de sciences économiques ( email )

C.P. 6128, succursale Centre-Ville
3150, rue Jean-Brillant, bureau C-6027
Montreal, Quebec H3C 3J7
Canada
514-985-4014 (Phone)

University of Montreal ( email )

United States

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