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Forecasting the performance of hedge fund styles

Jose Olmo () and Sanso-Navarro, Marcos

Journal of Banking & Finance, 2012, vol. 36, issue 8, 2351-2365

Abstract: This article predicts the relative performance of hedge fund investment styles using time-varying conditional stochastic dominance tests. These tests allow for the construction of dynamic trading strategies based on nonparametric density forecasts of hedge fund returns. During the recent financial turmoil, our tests predict a superior performance for the Global Macro investment style compared with the other strategies of ‘Directional Traders’. The Dedicated Short Bias investment style is stochastically dominated by the other directional styles. These results are confirmed by simple nonparametric tests constructed from realized excess returns. Further, by utilizing a cross-validation method for optimal bandwidth parameter selection, we discover the factors that have predictive power regarding the density of hedge fund returns. We observe that different factors have forecasting power for different regions of the returns distribution and, more importantly, that the Fung and Hsieh factors have power not only for describing the risk premium but also, if appropriately exploited, for density forecasting.

Keywords: Conditional density estimation; Hedge fund styles; Nonparametric methods; Portfolio performance; Stochastic dominance tests (search for similar items in EconPapers)
JEL-codes: C10 C20 G10 (search for similar items in EconPapers)
Date: 2012
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