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Unraveling Hedge Fund Returns: An Introduction to Independent Component Analysis as an Analytical Tool

Jan Olszewski

Perella Weinberg Partners

October 2006

Interest in hedge funds has grown tremendously over the past decade. As the market for hedge funds broadens, academics and practitioners are looking for new ways to examine these new financial vehicles. Currently, to uncover the factors that drive hedge fund returns, analysts either implement explicit factor models or implicit factor models such as principal component analysis. In this report, the implicit factor model of independent component analysis is introduced to analyze hedge fund returns. Using 119 equity long/short managers, a number of independent components are extracted along with a number of principal components. A comparison is conducted between the implicit factors indicating that the independent components explain different characteristics of hedge fund returns than the principal components obtained. To show how the independent components and principal components work with factor analysis, a small sample of managers is taken from the 119 hedge funds and all three methods were implemented. Findings indicate that there is value added in implementing independent component analysis in the analysis of hedge fund returns.

Number of Pages in PDF File: 29

Keywords: hedge funds, fund of funds, independent component analysis, principal component analysis, factor analysis

JEL Classification: C32, C45, C65, C81, G11, G23

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Date posted: February 22, 2006  

Suggested Citation

Olszewski, Jan, Unraveling Hedge Fund Returns: An Introduction to Independent Component Analysis as an Analytical Tool (October 2006). Available at SSRN: https://ssrn.com/abstract=884266 or http://dx.doi.org/10.2139/ssrn.884266

Contact Information

Jan Olszewski (Contact Author)
Perella Weinberg Partners
401 Congress Ave
Suite 3000
Austin, TX 78701
United States
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