Performance Evaluation of Hedge Funds with Option-Based and Buy-and-Hold Strategies

51 Pages Posted: 4 Oct 2000

See all articles by Vikas Agarwal

Vikas Agarwal

Georgia State University; University of Cologne - Centre for Financial Research (CFR)

Narayan Y. Naik

London Business School - Institute of Finance and Accounting

Date Written: August 2000

Abstract

Since hedge fund returns exhibit non-linear option-like exposures to standard asset classes (Fung and Hsieh (1997a, 2000a)), traditional linear factor models offer limited help in evaluating the performance of hedge funds. We propose a general asset class factor model comprising of excess returns on passive option-based strategies and on buy-and-hold strategies to benchmark the performance of hedge funds. Our model is a generalized version of Glosten and Jagannathan (1994) and it explicitly accounts for non-linear nature of payoffs displayed by hedge funds. Although in practice hedge funds can follow a myriad of dynamic trading strategies, we find that a few simple option writing/buying strategies are able to explain a significant proportion of variation in the hedge fund returns over time. In general, we find that hedge fund strategies added significant value (in excess of estimated survivorship bias) in the early nineties but less so in the late nineties. We also find that aggregated across all funds in our sample, hedge funds that do not use leverage show, on average, larger alphas and better information ratios compared to the funds that use leverage, across different time periods.

JEL Classification: G10, G19

Suggested Citation

Agarwal, Vikas and Naik, Narayan Y., Performance Evaluation of Hedge Funds with Option-Based and Buy-and-Hold Strategies (August 2000). EFA 0373; FA Working Paper No. 300. Available at SSRN: https://ssrn.com/abstract=238708 or http://dx.doi.org/10.2139/ssrn.238708

Vikas Agarwal (Contact Author)

Georgia State University ( email )

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HOME PAGE: http://www.gsu.edu/~fncvaa

University of Cologne - Centre for Financial Research (CFR)

Albertus-Magnus Platz
Cologne, 50923
Germany

Narayan Y. Naik

London Business School - Institute of Finance and Accounting ( email )

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London NW1 4SA
United Kingdom
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+44 20 724 3317 (Fax)

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