Is it Alpha or Beta? Decomposing Hedge Fund Returns When Models are Misspecified

David Ardia, Laurent Barras, Patrick Gagliardini and Olivier Scaillet
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Laurent Barras: University of Luxembourg
Patrick Gagliardini: Università della Svizzera italiana; Swiss Finance Institute

No 20-82, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: The decomposition of hedge fund returns is hampered by model misspecification. To address this issue, we develop a novel approach to compare models in a large population of funds. This comparison, which accounts for misspecification-driven estimation errors, sharpens the separation between alpha and beta. Our analysis reveals that: (i) prominent models are as misspecified as the CAPM, (ii) several factors—primarily time-series momentum, variance, carry—capture hedge fund strategies and lower performance, (iii) alpha and beta components correlate negatively and vary substantially across funds, consistent with equilibrium models featuring search costs, and (iv) fund valuation is sensitive to investor sophistication.

Keywords: Hedge fund returns; alpha; beta; model misspecification; large cross-section (search for similar items in EconPapers)
JEL-codes: C55 C58 G11 G12 G23 (search for similar items in EconPapers)
Pages: 81 pages
Date: 2020-09, Revised 2023-05
New Economics Papers: this item is included in nep-ore and nep-rmg
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Related works:
Journal Article: Is it alpha or beta? Decomposing hedge fund returns when models are misspecified (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2082

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