Evolutionary Changes, Survival and Selection of Hedge Funds
Date Issued
2009
Date
2009
Author(s)
Yang, Pei-Yu
Abstract
Sharpe ratio is a simple instrument of evaluation for funds in practice, but the accuracy of its estimator depends on the statistical properties of financial returns, thus measurement inaccuracy for the Sharpe ratio can lead to make wrong inference and decision. It is a constant task for both researchers and practitioners to use Sharpe ratio to evaluate whether a portfolio performs better than a certain benchmark index. In order to achieve this based on sound and statistical justification, it is necessary to derive the asymptotic distribution of the Sharpe ratio statistics of the benchmark of interest. Essay 1 of this study aims to extend the work of Ho (2006) by assuming that the return series follows a generalized stochastic volatility model in which the volatility component is formed by a general functional of a linear process. The study shows that both the and non- asymptotic normality are possible and the normalization constants are determined by the decay rate of the coefficients of the linear process that governs the volatility behavior of the returns.ssay 2 of this study provides some evidences about the development in the hedge fund industry over the past decade, focusing on the change in the composition of investors, preference for risk and reward, and the degree of competition. The change of hedge fund is closely related to the current industrial environment and its evolution, our findings include: (1).The change in the structure of the investors drives the result of the fact that the risk preference of the industry tends to be more conservative and affects the mainstream style of strategy during each phase in industrial development. (2).The dynamic competition effect for hedge funds across each strategy affect the fund survival and main strategy varied over competition and market condition. (3).The profit-making space of hedge funds is being gradually compressed due to more intense competition, besides; investors would have the benefit of industrial contest, which have wider and more flexible choice of target investments. Therefore, investors are more rigorous for required returns and less patient to undertake a loss than before. (4).Young hedge funds face harder survival environment than before and have great difficulty to survive during elimination. (5).The overall hedge funds abandoned upside gains in the terminal bull market to reduce the reversal loss, and raised a tendency towards risk control. ssay 3 of this study first investigates the key to the survival of the fittest by way of analyzing the difference between groups of the successful funds and other live or defunct funds. Next, in consideration of the right censoring for survival data, we use the survival models such as the Kaplan-Meier model, Cox proportional hazard model to confirm whether these factors are good predictor variables related to hedge funds’ survival and estimate the survival function and time of the hedge fund. Lastly, we construct a composite filter, which make use of the relevant covariates of hazard rate, to select funds and compare the out-of-sample performance and attrition rate with the Sharpe ratio. The findings include: (1).The poor absolute, relative performance and high volatility increase the risk of failure, however, the no effect of the standard deviation of relative performance. (2).Different initial sizes lead to different investment philosophies as young age. The successful funds with an initial small size will dynamically adjust their risk/reward relationship during the lifecycle phase. (3).Directional funds are more sensitive to size than non-directional funds. The stability of the flows is the key to survival for small funds and change of favorite by investors is one factor which leads large funds to close. (4).The recovering ability of maximum loss during the tolerant period given by investors becomes a necessary condition of survival. (5).The characteristics of high water mark and providing audited reports are important factors of hedge funds’ survival. The funds that do not pay attention investor’s right and have the potential agency conflicts will be eliminated from competition. (6).The composite filter indeed provides the function of decreasing the attrition rate, especially, the effect for small fund selection is significant (7).Using the recovery rate to screen non-directional targets performs well and the Sharpe ratio is properly to select more volatile large targets.
Subjects
Hedge fund
Sharpe ratio
Survival analysis
SDGs
Type
thesis
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