Optional and Conditional Components in Hedge Fund Returns
70 Pages Posted: 17 Mar 2006
Date Written: October 1, 2006
Abstract
We examine the ability of the factor model approach to evaluate the performance and persistence of hedge fund returns. In our analysis we incorporate traditional asset based factors as well as an array of new and previously studied option based factors. We provide evidence that there is still much information embedded in option prices, particularly in the implied higher moments, which has not previously been exploited. We utilize the framework of Bakshi, Kapadia and Madan (2003) who identify the prices of the implied variance, skewness and kurtosis contracts, and also propose a new approach to evaluate pseudo-moments using out-of-the-money option prices. These new option based factors increase the explanatory power of the models across all the hedge fund strategies, and provide added information that allows us to better predict persistence in returns.
Keywords: hedge funds, implied higher moments, performance, persistence
JEL Classification: G12
Suggested Citation: Suggested Citation
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