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Efficient Fund of Hedge Funds Construction Under Downside Risk Measures

23 Pages Posted: 4 May 2006  

David Morton

University of Texas at Austin - College of Engineering

Ivilina Popova

Texas State University - San Marcos

Elmira Popova

University of Texas at Austin

Abstract

We consider portfolio allocation in which the underlying investment instruments are hedge funds. Benchmarks and conditional-value-at-risk motivate a family of utility functions involving the probability of outperforming a benchmark and expected shortfall from another benchmark. Non-normal return vectors with prescribed marginal distributions and correlation structure are modeled and simulated using the normal-to-anything method. A Monte Carlo procedure is used to obtain, and establish the quality of, a solution to the associated portfolio optimization model. Computational results are presented on a problem in which we construct a fund of 13 CSFB/Tremont hedge-fund indices.

Keywords: Portfolio choice, expected regret, hedge funds, fund of funds, portfolio optimization, Monte Carlo simulation

JEL Classification: C15, C61, G11

Suggested Citation

Morton, David and Popova, Ivilina and Popova, Elmira, Efficient Fund of Hedge Funds Construction Under Downside Risk Measures. Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=900006

David Morton

University of Texas at Austin - College of Engineering ( email )

1 University Station
Austin, TX 78712-1179
United States

Ivilina Popova (Contact Author)

Texas State University - San Marcos ( email )

601 University Drive
San Marcos, TX 78666-4616
United States

HOME PAGE: http://www.business.txstate.edu/users/ip12/

Elmira Popova

University of Texas at Austin ( email )

Austin, TX 78712
United States

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