Emanuel Derman Volume 5, Number 3, Third Quarter 2007 What excess return should a fund of funds expect to earn for investing in a hedge fund with an extended lockup? In this paper, we present a simple model for estimating the premium for long-term lockups. Because there is a demonstrated statistical persistence to the quality… Read more
2007
BOOK REVIEWS: Fortune’s Formula
Volume 5, Number 4, Fourth Quarter 2007 Fortune’s Formula William Poundstone Reviewed by Javier Estrada View PDF… Read more
CASE STUDIES: Dependable Trust
Jack L. Treynor Volume 5, Number 4, Fourth Quarter 2007 View PDF… Read more
Interest Rate Models Implied Volatility Function Stochastic Movements
Thomas S. Y. Ho and Blessing Mudavanhu Volume 5, Number 4, Fourth Quarter 2007 This paper presents a one-factor and a two-factor arbitrage-free interest rate models with parsimonious implied volatility functions. The models are empirically tested on the entire swaption surface in three currencies (US dollar, Euro, and Japanese yen) over a 5-year period. They… Read more
The Pricing of Credit Default Swaps During Distress
Jochen R. Andritzky and Manmohan Singh Volume 5, Number 4, Fourth Quarter 2007 Credit default swaps (CDS) provide the buyer with insurance against certain types of credit events by entitling him to exchange any of the bonds permitted as deliverable against their par value. Unlike bonds, whose risk spreads are assumed to be the product… Read more
What Happened to the Quants in August 2007
Amir E. Khandani and Andrew W. Lo Volume 5, Number 4, Fourth Quarter 2007 During the week of August 6, 2007, a number of quantitative long/short equity hedge funds experienced unprecedented losses. Based on TASS hedge-fund data and simulations of a specific long/short equity strategy, we hypothesize that the losses were initiated by the rapid… Read more
Contingent Claims Approach to Measuring and Managing Sovereign Credit Risk
Dale F. Gray, Robert C. Merton and Zvi Bodie Volume 5, Number 4, Fourth Quarter 2007 This paper proposes a new approach to measure, analyze, and manage sovereign risk based on the theory and practice of modern contingent claims analysis (CCA). The paper provides a new framework for adapting the CCA model to the sovereign… Read more
INSIGHTS: A Brief Review of “The Basis”
James Batterman Volume 5, Number 4, Fourth Quarter 2007 Credit derivatives provide an alternative to the cash market, allowing investors to manage exposure to a wide range of entities. In a brief case study looking at several relatively volatile corporate names, we set out to describe, in general terms, the nature and behavior of the… Read more
BOOK REVIEWS: Financial Modeling of the Equity Market: From CAPM to Cointegration
Volume 5, Number 2, Second Quarter 2007 Financial Modeling of the Equity Market: From CAPM to Cointegration Frank J. Fabozzi, Sergio M. Facardi and Peter N. Kolm Reviewed by Cel Kulasekaran View PDF… Read more
CASE STUDIES: Common Sense Investing
Jack L. Treynor Volume 5, Number 1, First Quarter 2007 View PDF… Read more
Hedge Fund Mergers
Nusret Cakici and Sris Chatterjee Volume 5, Number 2, Second Quarter 2007 This paper examines the characteristics of merged hedge-funds. The data indicate that merged hedge-funds are larger funds that have underperformed over a two-year period prior to merger and have suffered from significantly lower money-flow prior to merger. Merged hedge-funds are also older funds… Read more
Timing Ability in the Focus Market of Hedge Funds
Yong Chen Volume 5, Number 2, Second Quarter 2007 This paper examines the timing ability of hedge funds covering various investment categories. We extend the Treynor-Mazuy (1966) and Henriksson-Merton (1981) market timing models to a multiple market framework and propose the concept of a focus market in which a fund trades most actively. Concentrating on… Read more
Will Hedge Funds Regress towards Index-like Products?
William Fung and David A. Hsieh Volume 5, Number 2, Second Quarter 2007 Hedge funds have grown substantially in the past few years even as hedge fund performance has declined with the rapid increase of capital. History tells us that over-priced, active managers will be replaced by low-cost, passive, index-like alternatives. Could the same process… Read more
How Hedge Funds Beat the Market
Craig French and Damian Ko Volume 5, Number 2, Second Quarter 2007 This paper investigates the determinants of hedge fund portfolio performance — whether hedge funds exhibit security selection skill and market-timing skill. We examine a sample of 157 long-short equity hedge funds over the 10-year period from January, 1996 through December, 2005. To account… Read more
Can Hedge-Fund Returns Be Replicated?: The Linear Case
Jasmina Hasanhodzic and Andrew W. Lo Volume 5, Number 2, Second Quarter 2007 In contrast to traditional investments such as stocks and bonds, hedge-fund returns have more complex risk exposures that yield additional and complementary sources of risk premia. This raises the possibility of creating passive replicating portfolios or \clones” using liquid exchange-traded instruments that… Read more
BOOK REVIEWS: Louis Bachelier’s Theory of Speculation
Volume 5, Number 3, Third Quarter 2007 Mark Davis and Alison Etheridge Reviewed by Hans-Christian Luedmann View PDF… Read more
Performance-Based Fees and Risk Shifting with the Knockout Barrier
Xiaodong Xu and Bernd Scherer Volume 5, Number 3, Third Quarter 2007 Many investment firms reward portfolio managers based on their performance. This article investigates a manager’s optimal active risk policy using stochastic programming techniques. Our multiple-period model incorporates the most common incentive-fee structures, and captures the risk that the manager is fired for underperformance… Read more
Active 130/30 Extensions: Alpha Hunting at the Fund Level
Martin L. Leibowitz and Anthony Bova Volume 5, Number 3, Third Quarter 2007 Active equity strategies that are highly benchmark-centric will generally have a minimal impact on fund-level volatility. Since most US institutional portfolios are overwhelmingly dominated by their equity exposure, any incremental tracking error will be submerged by the beta effect. Positive alpha opportunities… Read more
On the Relative Performance of Multi-Strategy and Funds of Hedge Funds
Vikas Agarwal and Jayant R. Kale Volume 5, Number 3, Third Quarter 2007 Recently, there has been explosive growth in two products from the hedge fund industry multi-strategy (MS) funds and funds of hedge funds (FOFs), both of which offer diversification across different hedge fund strategies. In well functioning markets, both investment vehicles should offer… Read more
What Every Investor Should Know About Commodities Part II: Multivariate Return Analysis
Harry M. Kat and Roel C. A. Oomen Volume 5, Number 3, Third Quarter 2007 In this paper, we study the multivariate return properties of a large variety of commodity futures. We find that between commodity groupings (such as metals, energy, etc.) correlations are very low and mostly insignificant whereas within groups they tend to… Read more
INSIGHTS: Will the Phillips Curve Cause WWIII?
Jack L. Treynor Volume 5, Number 3, Third Quarter 2007… Read more
BOOK REVIEWS: A Behavioral Approach To Asset Pricing / Investors and Markets
Volume 5, Number 1, First Quarter 2007 A Behavioral Approach To Asset Pricing Hersh Shefrin Reviewed by Hans-Christian Ludemann Investors and Markets William Sharpe Reviewed by Craig W. French View PDF… Read more
CASE STUDIES: Rivalry at Appleton-Pearson
Jack L. Treynor Volume 5, Number 2, Second Quarter 2007 View PDF… Read more
Proxy Voting Brand Competition
Mark Latham Volume 5, Number 1, First Quarter 2007 Institutional and individual investors can coordinate their proxy voting to improve corporate governance. A new funding design for professional proxy advisors can increase their quality and competition. These reforms would reduce the need for the public sector to police boards of directors by onerous regulation and… Read more
The Value of Transaction Cost Forecasts: Another Source of Alpha
Mark Coppejans and Ananth Madhavan Volume 5, Number 1, First Quarter 2007 This article examines the impact of transaction costs on portfolio performance. Previous research on this topic has focused largely on post-trade considerations, i.e., the impact of realized transaction costs on investment performance. By contrast, we focus on pre-trade considerations, namely the impact of… Read more
Industry Concentration and Mutual Fund Performance
Marcin Kacperczyk, Clemens Sialm and Lu Zheng Volume 5, Number 1, First Quarter 2007 We study the relation between the industry concentration and the performance of actively managed U.S. mutual funds from 1984 to 2003. Our results indicate that the most concentrated funds perform better after controlling for risk and style differences using factor-based performance… Read more
Measuring the True Cost of Active Management by Mutual Funds
Ross M. Miller Volume 5, Number 1, First Quarter 2007 This article derives a rigorous method for allocating fund expenses between active and passive management and that enable one to compute the implicit cost of active management. Computing this “active expense ratio” requires only a fund’s published expense ratio, its R-squared relative to a benchmark… Read more
What Every Investor Should Know About Commodities Part I: Univariate Return Analysis
Harry M. Kat and Roel C. A. Oomen Volume 5, Number 1, First Quarter 2007 In this paper we study the univariate return properties of a large variety of commodity futures. Our analysis shows that the volatility of commodity futures is comparable to that of US large cap stocks. Yet, with the exception of energy… Read more
CASE STUDIES: Reifen AG
Jack L. Treynor Volume 5, Number 1, First Quarter 2007 View PDF… Read more