Is it Alpha or Beta? Decomposing Hedge Fund Returns When Models are Misspecified

83 Pages Posted: 18 Sep 2020 Last revised: 27 Jan 2024

See all articles by David Ardia

David Ardia

HEC Montreal - Department of Decision Sciences

Laurent Barras

Universite du Luxembourg - Department of Finance

Patrick Gagliardini

University of Lugano; Swiss Finance Institute

O. Scaillet

Swiss Finance Institute - University of Geneva

Date Written: June 2, 2021

Abstract

We develop a novel approach to separate alpha and beta under model misspecification. It comes
with formal tests to identify less misspecified models and sharpen the return decomposition of individual funds. Our hedge fund analysis reveals that: (i) prominent models are as misspecified as the CAPM, (ii) several factors (time-series momentum, variance, carry) capture alternative strategies and lower performance in all investment categories, (iii) fund heterogeneity in alpha and beta is large—an important result for fund selection and models of active management, (iv) performance is increasingly similar to mutual funds, (v) fund valuation is sensitive to investor sophistication.

Keywords: Hedge fund returns, alpha, beta, model misspecification, large cross-section

JEL Classification: C55, C58, G11, G12, G23

Suggested Citation

Ardia, David and Barras, Laurent and Gagliardini, Patrick and Scaillet, Olivier, Is it Alpha or Beta? Decomposing Hedge Fund Returns When Models are Misspecified (June 2, 2021). Journal of Financial Economics, Forthcoming , Available at SSRN: https://ssrn.com/abstract=3661751 or http://dx.doi.org/10.2139/ssrn.3661751

David Ardia

HEC Montreal - Department of Decision Sciences ( email )

3000 Côte-Sainte-Catherine Road
Montreal, QC H2S1L4
Canada

Laurent Barras (Contact Author)

Universite du Luxembourg - Department of Finance ( email )

L-1511 Luxembourg
Luxembourg

Patrick Gagliardini

University of Lugano ( email )

Via Buffi 13
Lugano, TN 6900
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Olivier Scaillet

Swiss Finance Institute - University of Geneva ( email )

Geneva
Switzerland

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