Bringing Order to Chaos: Capturing Relevant Information with Hedge Fund Factor Models

42 Pages Posted: 14 Oct 2016 Last revised: 15 Mar 2017

See all articles by Yongjia Li

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: March 14, 2017

Abstract

We propose using ETF returns as proxies for tradable risk factors in hedge fund performance evaluation, identifying contemporaneously relevant risk factors from the entire universe of ETFs. Our model provides more informative estimates of alpha and beta coefficients for predicting hedge fund out-of-sample performance compared with other widely used hedge fund factor models. Portfolios of top alpha hedge funds selected by our model generate statistically significant out-of-sample performance that is substantially higher compared with portfolios selected by other models. In addition, our beta-weighted clone portfolios exhibit substantially higher out-of-sample correlations with underlying hedge funds than clone portfolios formed using alternative models.

Keywords: active investment, factor selection, ETFs, risk factor exposures, return attribution, hedge funds, alpha, beta, performance prediction

JEL Classification: G11, G23

Suggested Citation

Li, Yongjia and Malakhov, Alexey, Bringing Order to Chaos: Capturing Relevant Information with Hedge Fund Factor Models (March 14, 2017). Available at SSRN: https://ssrn.com/abstract=2852211 or http://dx.doi.org/10.2139/ssrn.2852211

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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