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Wavelet multiscale analysis for Hedge Funds: Scaling and strategies

Thomas Conlon (), M. Crane and H.J. Ruskin

Physica A: Statistical Mechanics and its Applications, 2008, vol. 387, issue 21, 5197-5204

Abstract: The wide acceptance of Hedge Funds by Institutional Investors and Pension Funds has led to an explosive growth in assets under management. These investors are drawn to Hedge Funds due to the seemingly low correlation with traditional investments and the attractive returns. The correlations and market risk (the Beta in the Capital Asset Pricing Model) of Hedge Funds are generally calculated using monthly returns data, which may produce misleading results as Hedge Funds often hold illiquid exchange-traded securities or difficult to price over-the-counter securities. In this paper, the Maximum Overlap Discrete Wavelet Transform (MODWT) is applied to measure the scaling properties of Hedge Fund correlation and market risk with respect to the S&P 500. It is found that the level of correlation and market risk varies greatly according to the strategy studied and the time scale examined. Finally, the effects of scaling properties on the risk profile of a portfolio made up of Hedge Funds is studied using correlation matrices calculated over different time horizons.

Keywords: Scaling; Cross-correlation; Wavelets; Hedge Funds; Econophysics (search for similar items in EconPapers)
Date: 2008
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DOI: 10.1016/j.physa.2008.05.046

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Physica A: Statistical Mechanics and its Applications is currently edited by K. A. Dawson, J. O. Indekeu, H.E. Stanley and C. Tsallis

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