Abstract
This paper compares performance of long-short equity hedge funds with the market index by using mean-variance criteria and criteria including higher moments. Based on the mean-variance criteria, the majority of the long-short equity hedge funds outperform the market index. When higher moments are used to evaluate the performance, a greater proportion of the hedge funds underperform the market index. This implies the importance of including higher moments in portfolio optimization.
Highlights
Investment performance evaluation compares achieved returns with model derived expected returns
The results show that while the majority of the hedge funds outperform the market index based solely on the mean-variance optimization techniques such as the Sharpe ratio and Jensen’s Alpha, the majority underperform the market index when skewness and kurtosis are included in the performance evaluation
Due to variations in the lives of the hedge funds, the number of return observations varies across funds
Summary
Investment performance evaluation compares achieved returns with model derived expected returns. Investment managers, especially the multi-billion hedge fund industry, try to exploit these observed inconsistencies with efficient markets and the non-normality of return distributions The results show that while the majority of the hedge funds outperform the market index based solely on the mean-variance optimization techniques such as the Sharpe ratio and Jensen’s Alpha, the majority underperform the market index when skewness and kurtosis are included in the performance evaluation.
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