MEASURING AND MONITORING THE EFFICIENCY OF MARKETS

Market efficiency is measured by arbitrage proximity. The level of efficiency is calibrated by extent of a distortion of probability required to neutralize the drift. Simulations of bilateral gamma models estimated from past returns deliver for each asset on each day an empirical acceptability index. The assets covered include equities, commodities, currencies, volatility and hedge fund returns. It is observed that efficiency in equity is related to the process for up moves having more frequent and smaller jumps than its down side counterpart. For commodities the situation is reversed. Volatility indices trade more efficiently than equities, commodities, or currencies. Hedge fund returns reflect lower levels of efficiency supportive of hedge funds effectively exploiting market inefficiences. The relative inefficiency of the absence of trading is noted on comparing close to open with open to close returns. Small capitalization stocks trade more efficiently than the large ones. Sector exchange traded funds trade more efficiently than the S&P 500 index. Furthermore, economic activity reflected in greater high low spreads enhance market efficiency.

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Are hedge fund returns affected by media coverage of macroeconomic news?

Studies in Economics and Finance ◽

10.1108/sef-10-2017-0289 ◽

2019 ◽

Vol 36 (3) ◽

pp. 427-439

Author(s):

Sandip Dutta ◽

James Thorson

Keyword(s):

Hedge Funds ◽

Media Coverage ◽

Hedge Fund ◽

Real Sector ◽

Macroeconomic News ◽

Content Type ◽

Fund Managers ◽

News Announcements ◽

Hedge Fund Returns ◽

The Impact

Purpose Extant literature suggests that the difficulty associated with the interpretation of macroeconomic news announcements by the market in general in different economic environments, might be the reason why most studies do not find any significant relationship between real-sector macroeconomic variables and financial asset returns. This paper aims to use a different approach to measure macroeconomic news. The objective is to examine if a different measure of a macroeconomic news variable, constructed from media coverage of the same, significantly affects hedge fund returns. Design/methodology/approach The authors use a news index for unemployment, which is a real-sector variable, constructed from newspaper coverage of unemployment announcements and examine its impact on hedge fund returns. Findings Contrary to the other studies that examine the impact of macroeconomic news on hedge fund returns, the authors find that media coverage of unemployment news announcements significantly affects hedge fund returns. Practical implications Overall, this paper demonstrates that the manner in which the market interprets macroeconomic news announcements in different economic environments is probably a more relevant factor for hedge funds and is more likely to impact hedge fund returns. In conjunction with variables – constructed from media coverage of unemployment news announcements – that factor in the manner of interpretation, it is found that surprises also matter for hedge fund returns. This is an important consideration for hedge fund managers as well. Originality/value To the best of the authors’ knowledge, this is the first study that examines the impact of media coverage of macroeconomic news announcements on hedge fund returns and finds significantly different results with real-sector macro variables.

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Hedge Fund Replication

10.1093/oso/9780190607371.003.0025 ◽

2017 ◽

Author(s):

Mikhail Tupitsyn ◽

Paul Lajbcygier

Keyword(s):

Hedge Funds ◽

Direct Investment ◽

Tracking Error ◽

Hedge Fund ◽

Cost Effective ◽

Secondary Markets ◽

Hedge Fund Replication ◽

Effective Manner ◽

Equity Indices ◽

Hedge Fund Returns

In theory, analogous to equity indices, hedge fund indices can provide broad exposure to hedge funds in a cost-effective manner. In practice, however, hedge fund indices are difficult to implement because direct investment in hedge funds is impractical. Unlike equities, hedge funds are not traded on liquid secondary markets and are often closed to new investment. A solution is hedge fund replication, which, rather than require direct investment in hedge funds, synthetically recreates hedge fund index returns by investing in portfolios that are exposed to the same underlying economic factors that drive hedge fund returns. This approach provides broad, cost-effective, hedge fund exposure and avoids the practical problems associated with direct hedge fund investment. As a consequence, such hedge fund clones exhibit lower tracking error and substantially higher raw and risk-adjusted returns than both investible and noninvestible hedge fund indices.

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Innovation and Informed Trading: Evidence from Industry ETFs

Review of Financial Studies ◽

10.1093/rfs/hhaa077 ◽

2020 ◽

Cited By ~ 4

Author(s):

Shiyang Huang ◽

Maureen O’Hara ◽

Zhuo Zhong

Keyword(s):

Market Efficiency ◽

Hedge Fund ◽

Informed Trading ◽

Risk Exposure ◽

Exchange Traded Funds ◽

Post Earnings Announcement Drift ◽

Earnings Surprises ◽

Short Interest ◽

The Impact ◽

Industry Risk

Abstract We empirically examine the impact of industry exchange-traded funds (IETFs) on informed trading and market efficiency. We find that IETF short interest spikes simultaneously with hedge fund holdings on the member stock before positive earnings surprises, reflecting long-the-stock/short-the-ETF activity. This pattern is stronger among stocks with high industry risk exposure. A difference-in-difference analysis on the ETF inception event shows that IETFs reduce post-earnings-announcement drift more among stocks with high industry risk exposure, suggesting that IETFs improve market efficiency. We also find that the short interest ratio of IETFs positively predicts IETF returns, consistent with the hedging role of IETFs.

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Hedge Funds and Financial Misreporting

10.1093/oxfordhb/9780198840954.013.20 ◽

2021 ◽

pp. 392-418

Author(s):

Philippe Jorion

Keyword(s):

Empirical Evidence ◽

Hedge Funds ◽

Hedge Fund ◽

Compensation System ◽

Good News ◽

Regulatory Environment ◽

Due Diligence ◽

Financial Misreporting ◽

Hedge Fund Returns

The growth of the hedge fund industry can be ascribed to its performance-based incentive compensation system as well as a lighter regulatory environment. These features, however, could also potentially create more opportunities for financial misreporting and even fraud. In response, recent research has attempted to detect misreporting by using due diligence information or by examining patterns in hedge fund returns. Empirical evidence suggests that hedge fund fraud can be usefully predicted from due diligence information, especially evidence of previous misrepresentation. Predicting misreporting from hedge fund returns, however, is much more difficult. This is because returns may reflect patterns in underlying assets instead of manager manipulation. For hedge fund investors, the good news is that the accumulated body of experience about detecting misreporting should help improve the quality of hedge fund investments. In addition, newly-imposed registration requirements for hedge fund advisors should also lower occurrences of misreporting.

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Hedge Funds: Do They Do What They Say They Do?

Journal of Business & Economics Research (JBER) ◽

10.19030/jber.v8i10.769 ◽

2010 ◽

Vol 8 (10) ◽

Author(s):

Scott P. Mackey ◽

Michael R. Melton

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Strongly Correlated ◽

Ample Evidence ◽

Investment Style ◽

Funds Of Hedge Funds ◽

Standard Linear ◽

Style Indices ◽

Fund Investment ◽

Hedge Fund Returns

The purpose of this research is two-fold, to determine if hedge funds follow their stated strategy styles and to examine how hedge funds’ strategy allocations evolve over time in response to changed economic and market conditions.  Our key advance is that we show that standard linear style models like that of Sharpe (1992) can be applied to hedge fund returns as long as the returns of the style indices in the model themselves display the nonlinear option-like characteristics of hedge fund returns.  For our research, the returns of our sample of Funds of Hedge Funds are strongly correlated to the returns of portfolios of hedge fund investment style indices.  In this way, we capture the spirit of Fung & Hsieh's (2002) Asset-Based Style Factors for Hedge Funds.  Based on our results, it appears that the answer to the first question is “somewhat”, while we find ample evidence of significant shifts in allocation among the Fund of Hedge Funds from the first sample period (1997-2001) to the second (2002-2006).  The changes in allocation appear to rationally reflect the changed economic conditions and investment opportunities existing at the time.

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Flagging potential fraudulent investment activity

Journal of Financial Crime ◽

10.1108/jfc-09-2015-0051 ◽

2016 ◽

Vol 23 (4) ◽

pp. 882-901

Author(s):

Jeremy King ◽

Gary Wayne van Vuuren

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Sharpe Ratio ◽

Financial Fraud ◽

Investment Activity ◽

Content Type ◽

Limited Success ◽

Bias Ratio ◽

Return Distributions ◽

Hedge Fund Returns

Purpose This paper aims to investigate the use of the bias ratio as a possible early indicator of financial fraud – specifically in the reporting of hedge fund returns. In the wake of the 2008-2009 financial crisis, numerous hedge funds were liquidated and several cases of financial fraud exposed. Design/methodology/approach Risk-adjusted return metrics such as the Sharpe ratio and Value at Risk were used to raise suspicion for fraud. These metrics, however, assume distributional normality and thus have had limited success with hedge fund returns (a characteristic of which is highly skewed, non-normal return distributions). Findings Results indicate that potential fraud would have been detected in the early stages of the scheme’s life. Having demonstrated the credibility of the bias ratio, it was then applied to several indices and (anonymous) South African hedge funds. The results were used to demonstrate the ratio’s scope and robustness and draw attention to other metrics which could be used in conjunction with it. Results from these multiple sources could be used to justify further investigation. Research limitations/implications The traditional metrics for performance evaluation (such as the Sharpe ratio), assume distributional normality and thus have had limited success with hedge fund returns (a characteristic of which is highly skewed, non-normal return distributions). The bias ratio, which does not rely on normally distributed returns, was applied to a known fraud case (Madoff’s Ponzi scheme). Practical implications The effectiveness of the bias ratio in demonstrating potential suspicious financial activity has been demonstrated. Originality/value The financial market has come under heightened scrutiny in the past decade (2005 – 2015) as a result of the fragile and uncertain economic milieu that still (2015) persists. Numerous risk and return measures have been used to evaluate hedge funds’ risk-adjusted performance, but many fail to account for non-normal return distributions exhibited by hedge funds. The bias ratio, however, has been demonstrated to effectively flag potentially fraudulent funds.

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Benchmarking and Bias in Hedge Funds

10.1093/oso/9780190607371.003.0027 ◽

2017 ◽

Author(s):

Jeffrey S. Smith ◽

Kenneth Small ◽

Phillip Njoroge

Keyword(s):

Selection Bias ◽

Hedge Funds ◽

Hedge Fund ◽

Academic Research ◽

Fund Performance ◽

Measurement Bias ◽

Return Smoothing ◽

Survivorship Bias ◽

Hedge Fund Returns ◽

Hedge Fund Performance

This chapter discusses investment benchmarking and measurement bias in hedge fund performance. A good benchmark should be unambiguous, investible, measurable, appropriate, reflective of current investment opinions, specified in advance, and accountable. Additionally, a good benchmark should be simple, easily replicable, comparable, and representative of the market that the benchmark is trying to capture. Several biases, such as database selection bias, survivorship bias, style classification bias, backfill bias, self-reporting bias, and return-smoothing bias exist that impede the process of creating a benchmark. These biases increase the difficulty of studying hedge fund returns and managerial skill. However, most of the academic research on hedge fund returns report positive alphas for hedge funds.

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Hedge Funds and Limits-to-Arbitrage: Does Financial Intermediaries’ Risk Predict Hedge Fund Returns?

SSRN Electronic Journal ◽

10.2139/ssrn.3302186 ◽

2018 ◽

Author(s):

Adrien Becam

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Financial Intermediaries ◽

Limits To Arbitrage ◽

Hedge Fund Returns

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Investor behavior: hedge fund returns and strategies

Review of Behavioral Finance ◽

10.1108/rbf-09-2015-0036 ◽

2017 ◽

Vol 9 (1) ◽

pp. 14-42 ◽

Cited By ~ 1

Author(s):

Andres Bello ◽

Jan Smolarski ◽

Gökçe Soydemir ◽

Linda Acevedo

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Management Style ◽

Active Management ◽

Warning Sign ◽

Content Type ◽

Market Sentiment ◽

Irrational Behavior ◽

Market Fundamentals ◽

Hedge Fund Returns

Purpose The purpose of this paper is to investigate to what extent hedge funds are subject to irrationality in their investment decisions. The authors advance the hypothesis that irrational behavior affects hedge fund returns despite their sophistication and active management style. Design/methodology/approach The irrational component may follow a pattern consistent with the observed hedge fund returns yet far distant from market fundamentals. The authors include factors beyond the original version of capital asset pricing model such as Fama and French and Carhart models, as well as less stringent models, such as APT and Fung and Hsieh, to test whether these models are able to capture the irrational nature of the residuals. Findings After finding that institutional irrational sentiments play a role in hedge fund returns, we note that the returns are not completely shielded against irrational trading; however, hedge fund returns appear to be affected only by the irrational component derived from institutional trading rather than that emanated from individuals. Research limitations/implications Different sources of irrationality may have asymmetric effects on hedge fund returns. Using a different set of sophisticated investors along with different market sentiment proxies may yield different results. Practical implications The authors argue that investors can use irrational beta to gauge the extent of institutional irrational sentiments prevailing in markets for the purpose of re-adjusting their portfolios and therefore use the betas as an early warning sign. It can also guide investors in avoiding funds and strategies that display greater irrational behavior. Originality/value The study advance the idea that the unexpected, hereafter irrational, component may follow a pattern consistent with the observed hedge fund returns, yet different from market fundamentals.

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A Longer Look at the Asymmetric Dependence between Hedge Funds and the Equity Market

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109010000219 ◽

2010 ◽

Vol 45 (3) ◽

pp. 763-789 ◽

Cited By ~ 18

Author(s):

Byoung Uk Kang ◽

Francis In ◽

Gunky Kim ◽

Tong Suk Kim

Keyword(s):

Hedge Funds ◽

Hedge Fund ◽

Tail Dependence ◽

Dependence Structure ◽

Investment Horizon ◽

Copula Theory ◽

Historical Simulation ◽

Asymmetric Dependence ◽

Current Availability ◽

Hedge Fund Returns

AbstractThis paper reexamines, at a range of investment horizons, the asymmetric dependence between hedge fund returns and market returns. Given the current availability of hedge fund data, the joint distribution of longer-horizon returns is extracted from the dynamics of monthly returns using the filtered historical simulation; we then apply the method based on copula theory to uncover the dependence structure therein. While the direction of asymmetry remains unchanged, the magnitude of asymmetry is attenuated considerably as the investment horizon increases. Similar horizon effects also occur on the tail dependence. Our findings suggest that nonlinearity in hedge fund exposure to market risk is more short term in nature, and that hedge funds provide higher benefits of diversification, the longer the horizon.

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