Dynamic Linkages between Hedge Funds and Traditional Financial Assets: Evidence from Emerging Markets

Abstract

This paper analyses the short- and long-term relationships between hedge funds and traditional financial assets using multivariate cointegration analysis in order to investigate if the fees charged by hedge funds are justified for the kind of exposure they provide to investors. We therefore create an emerging market composite hedge fund index as well as region specific indices based upon a unique and large sample of 404 emerging market hedge funds obtained from the merger of two different databases. As to whether diversification benefits arise from adding emerging markets hedge funds to an emerging markets bond/equity portfolio, our results show that the advantages are significantly less for Eastern Europe than for the other emerging market regions of Asia and Latin America during the period January 1998 through May 2006. In summary, we find evidence that emerging market hedge funds in general are redundant securities for long-term investment horizons.

Keywords: Emerging markets, Asia, Latin America, Eastern Europe, hedge funds, Johansen cointegration test, asset allocation, portfolio diversification

JEL Classification: C32, G11, G15