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Measuring Hedge Fund Performance: A Markov Regime-Switching with False Discoveries Approach

28 Pages Posted: 25 Feb 2016  

Gulten Mero

University of Cergy-Pontoise - THEMA; National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST)

Date Written: February 24, 2016

Abstract

We propose a Markov regime-switching approach accounting for false discoveries in order to measure hedge fund performance. It enables us to extract information from both time-series and cross-sectional dimensions of panels of individual hedge fund returns in order to distinguish between skilled, unskilled and zero-alpha funds for a given state of the economy. Applying our approach to individual hedge funds belonging to the Long/Short Equity Hedge strategy, we find that their performance cannot be explained by luck alone, and that the proportion of zero-alpha funds in the population decreases when accounting for alpha regime dependence. However, the proportion of truly skilled funds is higher during expansion periods, while unskilled funds tend to be more numerous during recession periods. Moreover, sorting on regime dependent alphas instead of unconditional alphas improves investors' ability to select funds that outperform their benchmarks in both regimes of the economy by maximizing the performance persistence effect of top performer fund portfolios.

Keywords: Hedge fund performance, Markov regime-switching factor models, false discovery rates, business cycles, portfolio choice

JEL Classification: C58, G11, G12

Suggested Citation

Mero, Gulten, Measuring Hedge Fund Performance: A Markov Regime-Switching with False Discoveries Approach (February 24, 2016). Available at SSRN: https://ssrn.com/abstract=2737385 or http://dx.doi.org/10.2139/ssrn.2737385

Gulten Mero (Contact Author)

University of Cergy-Pontoise - THEMA ( email )

33 boulevard du port
F-95011 Cergy-Pontoise Cedex, 95011
France

National Institute of Statistics and Economic Studies (INSEE) - Center for Research in Economics and Statistics (CREST) ( email )

15 Boulevard Gabriel Peri
Malakoff Cedex, 1 92245
France

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