Hedge Fund's Performance Black Box

Download or read book Hedge Fund's Performance Black Box written by Matthias Bäuml and published by . This book was released on 2009 with total page 58 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper addresses the question from where the superior returns of fixed income arbitrage hedge funds come. I show that a dynamic multi-linear replication strategy identifies style factors to which fixed income arbitrageurs are exposed. A forward and backward looking stepwise regression procedure reveals the link between asset-based style and return-based style factors from January 1998 to December 2007. The major findings are as follows: strategy-wise, the long-only exposure is steadily increasing over time whereas trend-following and convergence trades seem to replace passive spread trades. Location-wise, particularly swap spread arbitrage and convertible bond positions are held in the portfolios. At the same time, mortgage-backed securities and yield curve arbitrage activities diminish significantly; emerging markets and asset-backed securities market actions remain quite stable. I also find that the economic dependence on a particular style sharply increased over time: the last wave predicts that a one standard deviation movement in the convertible bond spread leads to a 661.56 bps swing in arbitrage returns. That said, my findings contribute to the understanding of the systematic risk caused by hedge funds. I also find good news for investors: the alpha share is positive in almost all sub-periods, economically significant, and an index based on my model would properly capture the statistical properties of fixed income arbitrage hedge funds.