Hedge Funds Quantitative Insights

ISBN-10: 047085667X

ISBN-13: 9780470856673

Edition: 2004

Authors: Fran�ois-Serge Lhabitant

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"An excellent and comprehensive source of information on hedge funds! From a quantitative view Lhabitant has done it once again by meticulously looking at the important topics in the hedge fund industry. This book has a tremendous wealth of information and is a valuable addition to the hedge fund literature. In addition, it will benefit institutional investors, high net worth individuals, academics and anyone interested in learning more about this fascinating and often mysterious world of privately managed money. Written by one of the most respected practitioners and academics in the area of hedge funds." -Greg N. Gregoriou, Professor of finance and research coordinator in the School of Business and Economics at Plattsburgh State University of New York. "This is a landmark book on quantitative approaches to hedge funds. All those with a stake in building hedge fund portfolios will highly profit from this exhaustive guide. A must read for all those involved in hedge fund investing." -Pascal Botteron, Ph.D., Head of Hedge Fund Product Development, Pictet Asset Management "Franois-Serge Lhabitant's second book will prove to be a bestseller too - just like Hedge Funds: Myths and Limits. He actually manages to make quantitative analysis 'approachable'- even for those less gifted with numbers. This book, like its predecessor, includes an unprecedented mix of common sense and sophisticated technique. A fantastic guide to the 'nuts and bolts' of hedge fund analysis and a 'must' for every serious investor." -Barbara Rupf Bee, Head of Alternative Fund Investment Group, HSBC Private Bank, Switzerland "An excellent book, providing deep insights into the complex quantitative analysis of hedge funds in the most lucid and intuitive manner. A must-have supplement to Lhabitant's first book dealing with the mystical and fascinating world of hedge funds. Highly recommended!" -Vikas Agarwal, Assistant Professor of Finance, J. Mack Robinson College of Business, Georgia State University "Lhabitant has done it again! Whereas most books on hedge funds are nothing more than glorified marketing brochures, Lhabitant's new book tells it how it is in reality. Accessible and understandable but at the same time thorough and critical." -Harry M. Kat, Ph.D., Professor of Risk Management and Director Alternative Investment Research Centre, Cass Business School, City University "Lhabitant's latest work on hedge funds yet again delivers on some ambitious promises. Successfully bridging theory and practice in a highly accessible manner, those searching for a thorough yet unintimidating introduction to the quantitative methods of hedge fund analysis will not be disappointed." -Christopher L. Culp, Ph.D., Adjunct Professor of Finance, Graduate School of Business, The University of Chicago and Principal, Chicago Partners LLC
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Book details

List price: $152.00
Copyright year: 2004
Publisher: John Wiley & Sons, Incorporated
Publication date: 7/2/2004
Binding: Hardcover
Pages: 354
Size: 6.75" wide x 9.75" long x 1.25" tall
Weight: 1.892
Language: English

Measuring Return and Risk
Characteristics of Hedge Funds
What are hedge funds?
Investment styles
The tactical trading investment style
The equity long/short style
The event-driven style
The relative value arbitrage style
Funds of funds and multi-strategy funds
The current state of the hedge fund industry
Measuring Return
The difficulties of obtaining information
Equalization, crystallization and multiple share classes
The inequitable allocation of incentive fees
The free ride syndrome
Onshore versus offshore funds
The multiple share approach
The equalization factor/depreciation deposit approach
Simple equalization
Consequences for performance calculation
Measuring returns
The holding period return
Multiple hedge fund aggregation
Continuous compounding
Return and Risk Statistics
Calculating return statistics
Central tendency statistics
Gains versus losses
Measuring risk
What is risk?
Range, quartiles and percentiles
Variance and volatility (standard deviation)
Some technical remarks on measuring historical volatility/variance
Back to histograms, return distributions and z-scores
Downside risk measures
From volatility to downside risk
Semi-variance and semi-deviation
The shortfall risk measures
Value at risk
Drawdown statistics
Benchmark-related statistics
Intuitive benchmark-related statistics
Beta and market risk
Tracking error
Risk-Adjusted Performance Measures
The Sharpe ratio
Definition and interpretation
The Sharpe ratio as a long/short position
The statistics of Sharpe ratios
The Treynor ratio and Jensen alpha
The market model
The Jensen alpha
The Treynor ratio
Statistical significance
Comparing Sharpe, Treynor and Jensen
Generalizing the Jensen alpha and the Treynor ratio
M[superscript 2], M[superscript 3] and Graham-Harvey
The M[superscript 2] performance measure
GH1 and GH2
Performance measures based on downside risk
The Sortino ratio
The upside potential ratio
The Sterling and Burke ratios
Return on VaR (Ro VaR)
Databases, Indices and Benchmarks
Hedge fund databases
The various biases in hedge fund databases
Self-selection bias
Database/sample selection bias
Survivorship bias
Backfill or instant history bias
Infrequent pricing and illiquidity bias
From databases to indices
Index construction
The various indices available and their differences
Different indices-different returns
Towards pure hedge fund indices
From indices to benchmarks
Absolute benchmarks and peer groups
The need for true benchmarks
Understanding the Nature of Hedge Fund Returns and Risks
Covariance and Correlation
Scatter plots
Covariance and correlation
Another interpretation of correlation
The Spearman rank correlation
The geometry of correlation and diversification
Why correlation may lead to wrong conclusions
Correlation does not mean causation
Correlation only measures linear relationships
Correlations may be spurious
Correlation is not resistant to outliers
Correation is limited to two variables
The question of statistical significance
Sample versus population
Building the confidence interval for a correlation
Correlation differences
Correlation when heteroscedasticity is present
Regression Analysis
Simple linear regression
Reality versus estimation
The regression line in a perfect world
Estimating the regression line
Illustration of regression analysis: Andor Technology
Measuring the quality of a regression: multiple R, R[superscript 2], ANOVA and p-values
Testing the regression coefficients
Reconsidering Andor Technology
Simple linear regression as a predictive model
Multiple linear regression
Multiple regression
Illustration: analyzing the Grossman Currency Fund
The dangers of model specification
The omitted variable bias
Extraneous variables
Serial correlation
Alternative regression approaches
Non-linear regression
Stepwise regression and automatic selection procedures
Non-parametric regression
Asset Pricing Models
Why do we need a factor model?
The dimension reduction
Linear single-factor models
Single-factor asset pricing models
Example: the CAPM and the market model
Application: the market model and hedge funds
Linear multi-factor models
Multi-factor models
Principal component analysis
Common factor analysis
How useful are multi-factor models?
Accounting for non-linearity
Introducing higher moments: co-skewness and co-kurtosis
Conditional approaches
Hedge funds as option portfolios
The early theoretical models
Modeling hedge funds as option portfolios
Do hedge funds really produce alpha?
Styles, Clusters and Classification
Defining investment styles
Style analysis
Fundamental style analysis
Return-based style analysis
The original model
Application to hedge funds
Rolling window analysis
Statistical significance
The dangers of misusing style analysis
The Kalman filter
Cluster analysis
Understanding cluster analysis
Clustering methods
Applications of clustering techniques
Allocating Capital to Hedge Funds
Revisiting the Benefits and Risks of Hedge Fund Investing
The benefits of hedge funds
Superior historical risk/reward trade-off
Low correlation to traditional assets
Negative versus positive market environments
The benefits of individual hedge fund strategies
Caveats of hedge fund investing
Strategic Asset Allocation--From Portfolio Optimizing to Risk Budgeting
Strategic asset allocation without hedge funds
Identifying the investor's financial profile: the concept of utility functions
Establishing the strategic asset allocation
Introducing hedge funds in the asset allocation
Hedge funds as a separate asset class
Hedge funds versus traditional asset classes
Hedge funds as traditional asset class substitutes
How much to allocate to hedge funds?
An informal approach
The optimizers' answer: 100% in hedge funds
How exact is mean-variance?
Static versus dynamic allocations
Dealing with valuation biases and autocorrelation
Optimizer's inputs and the GIGO syndrome
Non-standard efficient frontiers
How much to allocate to hedge funds?
Hedge funds as portable alpha overlays
Hedge funds as sources of alternative risk exposure
Risk Measurement and Management
Value at risk
Value at risk (VaR) is the answer
Traditional VaR approaches
The modified VaR approach
Extreme values
Approaches based on style analysis
Extension for liquidity: L-VaR
The limits of VaR and stress testing
Monte Carlo simulation
Monte Carlo for hedge funds
Looking in the tails
From measuring to managing risk
The benefits of diversification
Online References
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