Upside potential of hedge funds as a predictor of future performance

Turan G. Bali, Stephen Brown () and Mustafa O. Caglayan

Journal of Banking & Finance, 2019, vol. 98, issue C, 212-229

Abstract: This paper investigates the relationship between upside potential and future hedge fund returns. We measure upside potential based on the maximum monthly returns of hedge funds (MAX) over a fixed time interval, and show that MAX successfully predicts cross-sectional differences in future fund returns. Hedge funds with strong upside potential generate 0.70% per month higher average returns than funds with weak upside potential. After controlling for alternative risk and performance measures, funds’ market-timing ability, and a large set of fund characteristics, the positive link between MAX and future returns remains highly significant. We conclude that MAX, as a simple proxy for realized noln-normalities in hedge funds, offers incremental information on future hedge fund returns above and beyond provided by standard risk, performance, and market-timing measures.

Keywords: Hedge funds; Upside potential; Return predictability; JEL classification:; G10; G11; C13 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:98:y:2019:i:c:p:212-229

DOI: 10.1016/j.jbankfin.2018.11.003

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