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Passive Hedge Fund Replication – Beyond the Linear Case

Authors


  • We acknowledge financial support from NewEdge, the sponsor of the Research Chair in “Advanced Modelling Techniques for Hedge Fund Returns” at EDHEC Risk and Asset Management Research Center. We would also like to thank René Garcia, as well as an anonymous referee, for very useful comments. Correspondence: Lionel Martellini.

Abstract

In this paper we extendHasanhodzic and Lo (2007)by assessing the out-of-sample performance of various non-linear and conditional hedge fund replication models. We find that going beyond the linear case does not necessarily enhance the replication power. On the other hand, we find that selecting factors on the basis on an economic analysis allows for a substantial improvement in out-of-sample replication quality, whatever the underlying form of the factor model. Overall, we confirm the findings inHasanhodzic and Lo (2007)that the performance of the replicating strategies is systematically inferior to that of the actual hedge funds.

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