Is it Alpha or Beta? A Formal Evaluation of Hedge Fund Models

71 Pages Posted: 18 Sep 2020 Last revised: 1 Nov 2022

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

Decomposing hedge fund returns into alpha and beta is challenging because any benchmark model is unlikely to capture all the alternative hedge fund strategies. We develop a novel approach to test the ability of any proposed model to capture these strategies. This approach identifies sharper models and improves the decomposition of fund returns. Our tests reveal that standard factor models are similar to the CAPM and thus unable to capture alternative strategies. In contrast, a parsimonious model based on economically-motivated factors (including time-series momentum, carry, and variance) captures commmon hedge fund strategies and delivers a sizable reduction in performance.

Keywords: Hedge fund performance, alternative strategies, misspecification, model comparison

JEL Classification: G11, G12, C14, C33, C58

Suggested Citation

Ardia, David and Barras, Laurent and Gagliardini, Patrick and Scaillet, Olivier, Is it Alpha or Beta? A Formal Evaluation of Hedge Fund Models (June 2, 2021). Swiss Finance Institute Research Paper No. 20-82, 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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