In Search of Missing Risk Factors: Hedge Fund Return Replication with ETFs

55 Pages Posted: 20 Mar 2014 Last revised: 22 Jul 2018

See all articles by Jun Duanmu

Jun Duanmu

Louisiana Tech University - Department of Economics and Finance

Yongjia Li

Boise State University - College of Business and Economics, Department of Finance

Alexey Malakhov

University of Arkansas, Fayetteville - Sam M. Walton College of Business, Department of Finance

Date Written: July 12, 2018

Abstract

We develop a new factor selection methodology of spanning the space of hedge fund risk factors with all available exchange traded funds (ETFs). We demonstrate the efficacy of the methodology with out-of-sample hedge fund return replication, and find that the replication accuracy increases with the number of ETFs available. This is consistent with our interpretation of ETF returns as proxies to alternative risk factors driving hedge fund returns. We further consider portfolios of “cloneable” and “non-cloneable” hedge funds, defined as top and bottom in-sample R2 matches, and demonstrate that our ETF clone portfolios slightly outperform “cloneable” hedge funds out-of-sample.

Keywords: hedge funds, risk factor exposures, factor selection, return replication, performance measurement, performance prediction

JEL Classification: G11, G23

Suggested Citation

Duanmu, Jun and Li, Yongjia and Malakhov, Alexey, In Search of Missing Risk Factors: Hedge Fund Return Replication with ETFs (July 12, 2018). Available at SSRN: https://ssrn.com/abstract=2411910 or http://dx.doi.org/10.2139/ssrn.2411910

Jun Duanmu

Louisiana Tech University - Department of Economics and Finance ( email )

Ruston, LA 71272
United States

Yongjia Li

Boise State University - College of Business and Economics, Department of Finance ( email )

1910 University Drive
Boise, ID 83716
United States

Alexey Malakhov (Contact Author)

University of Arkansas, Fayetteville - Sam M. Walton College of Business, Department of Finance ( email )

Fayetteville, AR 72701
United States
479-575-6118 (Phone)
479-575-4230 (Fax)

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

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