We show that there is a high degree of serial correlation in most hedge fund returns to adjust volatility and correlation Performance of Hedge Funds.
Summary: Abstract: The returns to hedge funds and other alternative investments are often highly serially correlated in sharp contrast to the returns of more traditional investment vehicles such as long-only equity portfolios and mutual funds. In this paper, we explore several sources of such serial correlation and show that the most likely explanation is illiquidity exposure, i.e., investments in securities that are not actively traded and for which market prices are not always readily available. For portfolios of illiquid securities, reported returns will tend to be smoother than true economic returns, which will understate volatility and increase risk-adjusted performance measures such as the Sharpe ratio. We propose an econometric model of illiquidity exposure and develop estimators for the smoothing profile as well as a smoothing-adjusted Sharpe ratio. For a sample of 908 hedge funds drawn from the TASS database, we show that our estimated smoothing coefficients vary considerably across hedge-fund style categories and may be a useful proxy for quantifying illiquidity exposure. Read more... Abstract: Abstract: The returns to hedge funds and other alternative investments are often highly serially correlated in sharp contrast to the returns of more traditional investment vehicles such as long-only equity portfolios and mutual funds. In this paper, we explore several sources of such serial correlation and show that the most likely explanation is illiquidity exposure, i.e., investments in securities that are not actively traded and for which market prices are not always readily available. For portfolios of illiquid securities, reported returns will tend to be smoother than true economic returns, which will understate volatility and increase risk-adjusted performance measures such as the Sharpe ratio. We propose an econometric model of illiquidity exposure and develop estimators for the smoothing profile as well as a smoothing-adjusted Sharpe ratio. For a sample of 908 hedge funds drawn from the TASS database, we show that our estimated smoothing coefficients vary considerably across hedge-fund style categories and may be a useful proxy for quantifying illiquidity exposure. schema:datePublished "2003" schema:description "Abstract: The returns to hedge funds and other alternative investments are often highly serially correlated in sharp contrast to the returns of more traditional investment vehicles such as long-only equity portfolios and mutual funds. In this paper, we explore several sources of such serial correlation and show that the most likely explanation is illiquidity exposure, i.e., investments in securities that are not actively traded and for which market prices are not always readily available. For portfolios of illiquid securities, reported returns will tend to be smoother than true economic returns, which will understate volatility and increase risk-adjusted performance measures such as the Sharpe ratio. We propose an econometric model of illiquidity exposure and develop estimators for the smoothing profile as well as a smoothing-adjusted Sharpe ratio. For a sample of 908 hedge funds drawn from the TASS database, we show that our estimated smoothing coefficients vary considerably across hedge-fund style categories and may be a useful proxy for quantifying illiquidity exposure."@en schema:exampleOfWork <http://worldcat.org/entity/work/id/9127613> schema:inLanguage "en" schema:isPartOf 52313400 An econometric model of serial correlation and illiquidity in hedge fund returns/Mila Getmansky; Andrew W Lo; Igor Makarov; National Bureau of Economic Research.; Cambridge, Mass. : National Bureau of Economic Research, ©2003. 21274 book_digital
The returns to hedge funds and other alternative investments are often highly serially correlated in sharp contrast to the returns of more traditional investment.
MIT Sloan School of Management, 50 Memorial Drive, E52-432, Cambridge, MA 02142-1347, USA Received 16 October 2002, Revised 7 March 2003, Accepted 15 May 2003, Available online 10 July 2004 The returns to hedge funds and other alternative investments are often highly serially correlated. In this paper, we explore several sources of such serial correlation and show that the most likely explanation is illiquidity exposure and smoothed returns. We propose an econometric model of return smoothing and develop estimators for the smoothing profile as well as a smoothing-adjusted Sharpe ratio. For a sample of 908 hedge funds drawn from the TASS database, we show that our estimated smoothing coefficients vary considerably across hedge-fund style categories and may be a useful proxy for quantifying illiquidity exposure.
Serial Correlations in Investment Returns. 26 Aug. Posted by: PIPEs, private equity, tend to exhiit serial correlation. HFRI Hedge Fund Index Autocorrelations.
An econometric model of serial correlation and illiquidity in hedge fund returns