An Econometric Model of Serial Correlation and Illiquidity In Hedge Fund Returns

Mila Getmansky, Andrew Lo () and Igor Makarov

No 4288-03, Working papers from Massachusetts Institute of Technology (MIT), Sloan School of Management

Abstract: The returns to hedge funds and other alternative investments are often highly serially correlated in sharp contrast to the returns of more traditional investment vehicles such as long-only equity portfolios and mutual funds. In this paper, we explore several sources of such serial correlation and show that the most likely explanation is illiquidity exposure, i.e., investments in securities that are not actively traded and for which market prices are not always readily available. For portfolios of illiquid securities, reported returns will tend to be smoother than true economic returns, which will understate volatility and increase risk-adjusted performance measures such as the Sharpe ratio. We propose an econometric model of illiquidity exposure and develop estimators for the smoothing profile as well as a smoothing-adjusted Sharpe ratio. For a sample of 908 hedge funds drawn from the TASS database, we show that our estimated smoothing coefficients vary considerably across hedge-fund style categories and may be a useful proxy for quantifying illiquidity exposure

Keywords: Hedge Funds; Serial Correlation; Market Efficiency; Performance Smoothing; Liquidity (search for similar items in EconPapers)
Date: 2003-03-14
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

Downloads: (external link)
http://hdl.handle.net/1721.1/1838 (application/pdf)

Related works:
Journal Article: An econometric model of serial correlation and illiquidity in hedge fund returns (2004)
Working Paper: An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns (2003)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:mit:sloanp:1838

Ordering information: This working paper can be ordered from
MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), SLOAN SCHOOL OF MANAGEMENT, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA

Access Statistics for this paper

More papers in Working papers from Massachusetts Institute of Technology (MIT), Sloan School of Management MASSACHUSETTS INSTITUTE OF TECHNOLOGY (MIT), SLOAN SCHOOL OF MANAGEMENT, 50 MEMORIAL DRIVE CAMBRIDGE MASSACHUSETTS 02142 USA. Contact information at EDIRC.
Bibliographic data for series maintained by None ( this e-mail address is bad, please contact ).