Posted: 16 Jan 2011 Last revised: 11 Dec 2013
Date Written: August 1, 2013
This paper empirically decomposes hedge fund excess return into factor timing, security selection, and risk premium using Lo (2008)’s performance measure. Portfolio-level tests show that security selection explains most of the excess return generated by hedge funds during 1994-2009, and the contribution of factor timing is small. Fund-level tests find significant evidence of both positive and negative timing, but the excess return of positive timing funds is not significantly higher than that of the other funds. These findings imply that factor timing is not the main source of hedge fund alpha, and the results are robust to different factor models.
Keywords: Factor Timing, Security Selection, Hedge Fund Alpha, Return Decomposition
JEL Classification: G01, G11, G17, G23
Suggested Citation: Suggested Citation