Hedge Funds and Optimal Asset Allocation: Bayesian Expectations, Time-Varying Investment Opportunities and Mean-Variance Spanning

51 Pages Posted: 16 Sep 2011 Last revised: 8 Dec 2011

See all articles by Wolfgang Bessler

Wolfgang Bessler

Justus-Liebig-University Giessen

Julian Holler

University of Giessen - Center for Finance and Banking

Philipp Kurmann

University of Giessen - Center for Finance and Banking

Date Written: September 16, 2011

Abstract

In this paper we analyze the contribution of hedge funds in optimal asset allocations for different investor clienteles. The preferences of specific institutional investors are captured by implementing a Bayesian asset allocation framework that incorporates heterogeneous expectations regarding alpha. Mean-variance spanning tests are used to draw inferences on the ability of hedge funds to enhance the efficient frontier. A novel variance decomposition procedure is employed for analyzing the co-movement of hedge fund returns with the benchmark assets. The empirical findings strongly indicate that portfolio benefits of hedge funds are time-varying and crucially depend on investor optimism regarding hedge fund alpha. Allocations to hedge funds improve the global minimum variance portfolio even after controlling for short-selling restrictions and minimum diversification constraints. However, the factor structure of hedge fund returns has become more similar to the benchmark assets due to dynamics underlying the composition of the aggregate hedge fund universe.

Keywords: hedge funds, asset allocation

JEL Classification: G11, G23

Suggested Citation

Bessler, Wolfgang and Holler, Julian and Kurmann, Philipp, Hedge Funds and Optimal Asset Allocation: Bayesian Expectations, Time-Varying Investment Opportunities and Mean-Variance Spanning (September 16, 2011). Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1928320 or http://dx.doi.org/10.2139/ssrn.1928320

Wolfgang Bessler (Contact Author)

Justus-Liebig-University Giessen ( email )

Center for Finance and Banking
Licher Strasse 74
Giessen, D-35394
Germany
49-641-9922460 (Phone)
49-641-9922469 (Fax)

HOME PAGE: http://wiwi.uni-giessen.de/home/Bessler/

Julian Holler

University of Giessen - Center for Finance and Banking ( email )

Licher Strasse 74
Pouring
Giessen, D-35394
Germany

Philipp Kurmann

University of Giessen - Center for Finance and Banking ( email )

Licher Strasse 74
Giessen, D-35394
Germany

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