Performance Maximization of Actively Managed Funds

Journal of Finanical Economics, Vol. 101, No. 3. pp. 574-595, September 2011

51 Pages Posted: 22 Oct 2011

See all articles by Paolo Guasoni

Paolo Guasoni

Boston University - Department of Mathematics and Statistics; Dublin City University - School of Mathematical Sciences

Gur Huberman

Columbia Business School - Finance and Economics

Zhenyu Wang

University of Texas at Austin - Department of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: September 2011

Abstract

A growing literature suggests that even in the absence of any ability to predict returns, holding options on the benchmarks or trading frequently can generate positive alpha. The ratio of alpha to its tracking error appraises a fund's performance. This paper derives the performance-maximizing strategy, which turns out to be a variant of a buy-write strategy, and the least upper bound on such performance enhancement. If common equity indices are used as benchmarks, the potential alpha generated from trading frequently can be substantial in magnitude, but it carries considerable risk. The statistical significance in estimated alpha is low, and the probability of a negative alpha is high. The performance enhancement from holding options can be significant — both economically and statistically — if the options' implied volatilities are higher than the volatilities of the benchmark returns. The performance-maximizing strategy derived in this paper is different from the strategies that switch portfolio exposure to the bench-marks. The exposure-switching strategies are not promising unless the switching is based on superior information.

Suggested Citation

Guasoni, Paolo and Guasoni, Paolo and Huberman, Gur and Wang, Zhenyu, Performance Maximization of Actively Managed Funds (September 2011). Journal of Finanical Economics, Vol. 101, No. 3. pp. 574-595, September 2011 , Available at SSRN: https://ssrn.com/abstract=1947044

Paolo Guasoni

Boston University - Department of Mathematics and Statistics ( email )

Boston, MA 02215
United States

Dublin City University - School of Mathematical Sciences ( email )

Dublin
Ireland

HOME PAGE: http://www.guasoni.com

Gur Huberman (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
(212) 854-5553 (Phone)

Zhenyu Wang

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-5781 (Phone)

HOME PAGE: http://www.mccombs.utexas.edu/faculty/zhenyu.wang/

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