MANAGEMENT THESIS-II

WHETHER HEDGE FUNDS ADDED

MORE SENSITIVITY TO SENSEX

MANAGEMENT THESIS – II
Whether Hedge Funds added more sensitivity to BSE-Sensex?

SUBMITTED
BY
 A.SRIDHAR NAG
ENROLLMENT NO. 8NBHM039

SUBMITTED TO:
Prof.Dr.SHAIK MOULALI, FACULTY GUIDE (MT-II)
INC ADAM SMITH – HYDERABAD

A REPORT SUBMITTED IN PARTIAL FULFILMENT

OF THE REQUIREMENT OF
MASTERS DEGREE IN BUSINESS ADMINISTRATION
HYDERABAD

ACKNOWLEDGEMENT

I am extremely grateful to my Management Thesis-II,

Dr.SHAIK MOULALI Faculty guide, whose experienced guidance has
supported my honest efforts at all stages of my report.
I would like to express my heart-full gratitude to all those people
who had enabled the successful completion of my Final thesis of my
Management Thesis-II whose constant guidance and encouragement
crowned all my efforts with success.
 CONTENTS
TITLE PAGE
……………………………………………………………………….

ACKNOWLEDGEMENT
………………………………………………………………………..

ABSTRACT
……………………………………………………………………………..

CHAPTER I

 INTRODUCTION

CHAPTER II

 REVIEW OF LITERATURE
CHAPTER III

 RESEARCH METHODOLOGY

CHAPTER IV

 RESULTS AND ANALYSIS

CHAPTER V

 DISCUSSION OF IMPLICATION

CHAPTER VI

 CONCLUSIONS & RECOMMENDATION

REFERENCES

ABSTRACT

This paper examines the relationship between stock prices and

Hedge Funds i.e. Equity Hedge Funds for past ten years using

monthly time series data. The study uses Granger causality test
procedure developed by Granger, C.W.J. Hedge Funds are one

of the aim instruments on which market can bet on, not only to

reduce volatility and risk but also to preserve capital and

deliver positive returns under all market conditions

The causal relationship tested between the BSE index and

Hedge Funds. Hedge Funds is included in the model as an

additional variable, to examine whether Hedge Funds

added more Sensitivity to Sensex..

With the ADF UNIT ROOT TEST and JOHANSENS

COINTEGRATION TEST it is found that the trend lines are

deterministic and on applying GRANGERS CAUSALITY

TEST We found that Hedge Funds have causal relation with the

Sensex returns and vice versa

INTRODUCTION
A hedge fund is a fund that can take both long and short positions, use
arbitrage, buy and sell undervalued securities, trade options or bonds, and
invest in almost any opportunity in any market where it foresees
impressive gains at reduced risk. Hedge fund strategies vary enormously --
many hedge against downturns in the markets -- especially important today
with volatility and anticipation of corrections in overheated stock
markets. The primary aim of most hedge funds is to reduce volatility and
risk while attempting to preserve capital and deliver positive returns under
all market conditions.

There are approximately 14 distinct investment strategies used by

hedge funds, each offering different degrees of risk and return. A macro
hedge fund, for example, invests in stock and bond markets and other
investment opportunities, such as currencies, in hopes of profiting on
significant shifts in such things as global interest rates and countries’
economic policies. A macro hedge fund is more volatile but potentially
faster growing than a distressed-securities hedge fund that buys the equity
or debt of companies about to enter or exit financial distress. An equity
hedge fund may be global or country specific, hedging against downturns
in equity markets by shorting overvalued stocks or stock indexes. A
relative value hedge fund takes advantage of price or spread
inefficiencies. Knowing and understanding the characteristics of the many
different hedge fund strategies is essential to capitalizing on their variety
of investment opportunities.

It is important to understand the differences between the various hedge

fund strategies because all hedge funds are not the same -- investment
returns, volatility, and risk vary enormously among the different hedge
fund strategies. Some strategies which are not correlated to equity markets
are able to deliver consistent returns with extremely low risk of loss, while
others may be as or more volatile than mutual funds. A successful fund of
funds recognizes these differences and blends various strategies and asset
classes together to create more stable long-term investment returns than
any of the individual funds.

• Hedge fund strategies vary enormously – many, but not all, hedge
against market downturns – especially important today with
volatility and anticipation of corrections in overheated stock
markets.
• The primary aim of most hedge funds is to reduce volatility and
risk while attempting to preserve capital and deliver positive
(absolute) returns under all market conditions.
• The popular misconception is that all hedge funds are volatile --
that they all use global macro strategies and place large directional
bets on stocks, currencies, bonds, commodities or Hedge Funds,
while using lots of leverage. In reality, less than 5% of hedge funds
are global macro funds. Most hedge funds use derivatives only for
hedging or don’t use derivatives at all, and many use no leverage.

BSE SENSEX

The BSE SENSEX, short form of Sensitive Index, first compiled in 1986
is a “market Capitalization-Weighted” index of 30 component stocks
representing a sample of large, well-established and financially sound
companies. The index is widely reported in both, the domestic
international, print electronic media and is widely used to measure the used
to measure the performance of the Indian stock markets.

The BSE SENSEX is the benchmark index of the Indian capital market
and one, which has the longest social memory. In fact the SENSEX is
considered to be the pulse of the Indian stock markets. It is the oldest index
in India and has acquired a unique place in collective consciousness of the
investors. Further, as the oldest index of the Indian Stock Market, it
provides time series data over a fairly long period of time. Small wonder
that the SENSEX has over the years has become one of the most
prominent brands of the Country.

OBJECTIVES OF THE STUDY

 To study if there is any dynamic relationship between sensitivity of

Sensex and Hedge Funds

 To analyze the Causal relation of the Hedge funds with Sensex

returns

Literature review
 REVIEW OF LITERATURE

A significant amount of literature now exists that examines the relationship

between
Stock market returns and a range of macro economic and financial
variables over a
Number of different stock markets and time periods. Now a day’s financial
economics
Provide a number of models that helps to examine the relationship. The
return on stocks
is highly sensitive to both fundamentals and expectations. The latter in turn
is influenced
by the fundamentals which may be based on either rational or adaptive
expectation
models, as well as by many subjective factors which are unpredictable and
also non
quantifiable.
Exchange rate and stock market: evidence from India and Japan,
Journal of International Finance and Economics, published in
September 2007.

This paper empirically studies the issues of possible Granger causality and
interactive feedback relationships between exchange rate changes and
stock market returns of India and Japan. Daily data from January 1998
through December 2005 are employed. The time series data are found
stationary in levels by ADF (augmented Dickey-Fuller) test for unit root.
No discernible evidence of Granger causality is observed between the
above variables for Japan. However, such relationship is discovered in the
case of India, although not quite substantial. Evidence of very short-run
interactive feedback relationships exists in both countries. Japanese stock
and foreign exchange markets depict no intra-market risk-transmissions. In
the case of India, stock market seems to transmit relatively more risk to
foreign exchange market than the vice versa.
Martin Weber, The comovement of credit default swap, bond and
stock markets: an empirical analysis, published in January,2004
This paper analyzes the empirical relationship between credit
default swap, bond and stock markets during the period 2000-
2002. Focusing on the intertemporal comovement, we examine
weekly and daily lead-lag relationships in a vector autoregressive
model and the adjustment between markets caused by
cointegration. First, we find that stock returns lead CDS and
bond spread changes. Second, CDS spread changes Granger
cause bond spread changes for a higher number of firms than
vice versa. Third, the CDS market is significantly more sensitive
to the stock market than the bond market and the magnitude of
this sensitivity increases when credit quality becomes worse.
Finally, the CDS market plays a more important role for price
discovery than the corporate bond market

Mishra, Alok Kumar, Stock Market and Foreign Exchange Market in

India: Are they Related? South Asian Journal of Management,
published in April,2004.

This paper attempts to examine whether stock market and foreign

exchange market are related to each other or not. The study uses Granger's
Causality test and Vector Auto Regression technique on monthly stock
return, exchange rate, interest rate and demand for money for the period
April 1992 to March 2003. The major findings of the study are (a) there
exists a unidirectional causality between Exchange rate and interest rate
and between exchange rate return and demand for money; (b) there is no
Granger's causality between exchange rate return and stock return.
Through Vector Auto Regression
Abdulnasser Hatemi-J a; Eduardo Roca, Exchange rates and stock
prices interaction during good and bad times: evidence from the
ASEAN4 countries, Applied Economics, published in 2005

Using bootstrap causality tests with leveraged adjustments, the link

between exchange rates and stock prices in Malaysia, Indonesia,
Philippines and Thailand is investigated for the periods immediately before
and during the 1997 Asian crisis. Two variables are found to be
significantly linked in the non-crisis period but not at all during the crisis
period. The implications of this result in terms of hedging, market
efficiency, market integration and policy intervention are explained in the
paper.

Martin Bruand and Rajna Gibson-Asner, The effects of newly listed

derivatives in a thin stock market, Review of Derivatives
Research, published in April, 2005
This study examines the informational feedback effects associated to the
listing and trading of derivatives in Switzerland. The observed changes in
the price and higher moments of stock returns are representative of a thin
stock market. The listing of stock options and index futures generated
positive abnormal returns for large stocks and for the index while small
stocks essentially benefited from the launching of index options. While
reducing the variance of blue chips and of the index, their variance's
stochasticity increased (decreased) at index options' (futures) listings.
Finally, we detect significant stock and index derivatives' price leads
which do not however generate arbitrage opportunities.

J. Aaltonen and R. Östermar, rolling test of granger causality

between the Finnish and Japanese security markets,Published by
Elsevier Science Ltd. In June 1998

In the paper we test the impact of the Japanese stock market on two
financial asset groups, free and restricted shares, on the Finnish market in
the early 90s. The causality is tested in the Granger sense. The research
issue is particularly interesting, since the restrictions on foreign ownership
were abolished by the end of 1992. The linkage between the Japanese and
Finnish financial economies is seen to be stronger for free shares than for
restricted. In particular, significant Granger causality between Japanese
and Finnish free shares is observed at relatively long consecutive time
intervals, whereas the Japanese impact on the restricted shares is only
occasional. Thus, the decision to abolish the restrictions not only leads to
increased international dependence in the future, but will also change the
risk profile of the restricted shares.

The relationship between exchange rate and stock prices during the
quantitative easing policy in Japan, published in 2001

Japan experienced unprecedented recession and deflation for more than

10 years. The Bank of Japan enforced quantitative monetary easing at a
level never seen before. One purpose is to influence stock prices for
economic recovery. Recently, the Japanese economy has been in
recovery, and stock prices have increased. However, there is much dispute
over whether quantitative easing has been effective. This paper
investigates the relationship between macroeconomic variables and stock
prices. Exchange rate is the main target variable and finds that interest
rates have not impacted Japanese stock prices but exchange rates and U.S.
stock prices have. Furthermore, the Bank of Japan's policy for
overcoming recession and deflation has been effective.

R. Smyth a; M. Nandha, Bivariate causality between exchange rates

and stock prices in South Asia, Applied Economic Letters,
published in September,2003

This article examines the relationship between exchange rates and stock
prices in Bangladesh, India, Pakistan and Sri Lanka using daily data over a
six-year period from 1995 to 2001. Both the Engle-Granger two-step and
Johansen cointegration methods suggest that there is no long-run
equilibrium relationship between these two financial variables in any of the
four countries. Granger causality tests find that there is uni-directional
causality running from exchange rates to stock prices in India and Sri
Lanka, but in Bangladesh and Pakistan exchange rates and stock prices are
independent.

Feride Ozturk, Sezgin Acikalin, Is Hedge Funds a Hedge Against

Turkish Lira?South East European Journal of Economics and
Business, published in April,2008

This paper investigates whether Hedge Funds is an internal hedge and/or

an external hedge against Turkish lira (TL) by using monthly data from
January 1995 to November 2006. Cointegration test results confirm the
long-term relationships between the Hedge Funds price and consumer
price index and between the Hedge Funds price and TL/US dollar
exchange rate. The Granger Tests, based on vector error correction model
(VECM), indicate that Hedge Funds price Granger causes the consumer
price index and TL/US dollar exchange rate in a unidirectional way. It is
concluded that Hedge Funds acts as an effective hedge against potential
future TL depreciation and rising domestic inflation. Furthermore, Hedge
Funds price may be considered as a good indicator of inflation and hence it
can be used as a guide to monetary policy

Azman-Saini, W.N.W, Hedge funds, exchange rates and causality:

Evidence from Thailand and Malaysia, Journal of Econometrics,
published in 1995
This article contributes to the debate on hedge funds and exchange rates in
Thailand and Malaysia. It examines causal relations using a new Granger
non-causality procedure proposed by Toda and Yamamoto (Journal of
Econometrics, 66, 225-50, 1995). Monthly observations are utilized over a
sample period from January, 1994 to April, 2002. The results show that the
funds lead Thai baht for the crisis period. The results also reveal that the
funds lead Malaysian ringgit for the pre-crisis period

Kausik Chaudhuri, Cointegration, error correction and Granger

causality: an application with Latin American stock markets,
Applied Economics Letters, published in August, 1997.
This paper offers an empirical investigation of the presence of a long run
relationship in stock prices in six Latin Emerging Markets. We find
evidence of a long run relationship among all of these countries in a
bivariate framework. Results indicate the presence of bidirectional rather
than unidirectional causality suggesting the absence of weak exogeneity
among their stock prices.
Ralf Ostermark, Multivariate Granger causality in international asset
pricing: evidence from the Finnish and Japanese financial economies,
Applied Financial Economics, published in 1998
The present study combines the test of causality in multiple time series
with a rolling framework. The algorithm generates the time pattern of
causality of the underlying vector process. The algorithm is applied to
testing whether the Japanese stock market Granger causes the Finnish
derivatives market. The Japanese stock market is seen to Granger cause the
Finnish derivatives market at distinct time intervals within the sample
period, possibly during periods of regime switches, trend changes or major
global disturbances.

Adnan Kasman, and Saadet Kasman, the impact of futures trading on

volatility of the underlying asset in the Turkish stock market,
published in 2007

This paper examines the impact of the introduction of stock index futures
on the volatility of the Istanbul Stock Exchange (ISE), using asymmetric
GARCH model, for the period July 2002–October 2007. The results from
EGARCH model indicate that the introduction of futures trading reduced
the conditional volatility of ISE-30 index. Results further indicate that
there is a long-run relationship between spot and future prices. The results
also suggest that the direction of both long- and short-run causality is from
spot prices to future prices. These findings are consistent with those
theories stating that futures markets enhance the efficiency of the
corresponding spot markets.

Heather Tarbert,Is commercial property a hedge against inflation?: A

cointegration approach,Journal of Property Finance, Published in
1996

Historically, investment in commercial property has been perceived as

providing a hedge against inflation. A complete hedge against inflation is
formally defined as an asset where the nominal returns vary in a positive
one-for-one way with inflation. The belief that commercial property is an
inflation hedge has persisted, notwithstanding the fact that many empirical
tests have proven inconclusive. Use of the traditional methodology in this
paper also produces poor results, although the hypothesis that commercial
property is a hedge cannot be rejected. Explores the reasons for these poor
results, and introduces a method of testing for a long-run hedging
relationship, based on cointegration. Cointegration techniques reject the
hypothesis that commercial property is a consistent long-run hedge against
inflation.
Haus am Park, Rathausplatz 8-10, 61348 Bad Homburg, Germany,
The tactical and strategic value of hedge fund strategies:
a cointegration approach,Financial Markets and Portfolio
Management, published in August, 2007 .This paper analyzes
long-term comovements between hedge fund strategies and
traditional asset classes using multivariate cointegration
methodology. Since cointegrated assets are tied together over the
long run, a portfolio consisting of these assets will have lower
long-term volatility. Thus, if the presence of cointegration lowers
uncertainty, risk-averse investors should prefer assets that are
cointegrated. Long-term (passive) investors can benefit from the
knowledge of cointegrating relationships, while the built-in error
correction mechanism allows active asset managers to anticipate
short-run price movements. The empirical results indicate there
is a long-run relationship between specific hedge fund strategies
and traditional financial assets. Thus, the benefits of different
hedge fund strategies are much less than suggested by
correlation analysis and portfolio optimization. However, certain
strategies combined with specific stock market segments offer
portfolio managers adequate diversification potential, especially
in the framework of tactical asset allocation.

Jan G. De Gooijer, Selliah Sivarajasingham, Parametric and

nonparametric Granger causality testing: Linkages between
international stock markets,bDepartment of Economics, University of
Peradeniya, Peradeniya, Sri Lanka, published in November,2007. This
study investigates long-term linear and nonlinear causal linkages among
eleven stock markets, six industrialized markets and five emerging markets
of South-East Asia. We cover the period 1987–2006, taking into account
the on-set of the Asian financial crisis of 1997. We first apply a test for the
presence of general nonlinearity in vector time series. Substantial
differences exist between the pre- and post-crisis period in terms of the
total number of significant nonlinear relationships. We then examine both
periods, using a new nonparametric test for Granger noncausality and the
conventional parametric Granger noncausality test. One major finding is
that the Asian stock markets have become more internationally integrated
after the Asian financial crisis. An exception is the Sri Lankan market with
almost no significant long-term linear and nonlinear causal linkages with
other markets. To ensure that any causality is strictly nonlinear in nature,
we also examine the nonlinear causal relationships of VAR filtered
residuals and VAR filtered squared residuals for the post-crisis sample. We
find quite a few remaining significant bi- and uni-directional causal
nonlinear relationships in these series. Finally, after filtering the VAR-
residuals with GARCH-BEKK models, we show that the nonparametric
test statistics are substantially smaller in both magnitude and statistical
significance than those before filtering. This indicates that nonlinear
causality can, to a large extent, be explained by simple volatility effects

David Stewart, Swapan Sen, John Malindretos, Krishna M.

Kasibhatla,, Are daily price indices in Major European markets
Cointegrated?Tests and Evidence. American Economist, 2006

This study investigates short-run and long-run linkages among major West
European equity markets in London (FTSE100), Frankfurt (DAX30), and
Paris (CAC40). Long-run market co-movements of the three price indices
are detected employing cointegration and vector error correction
methodology. Empirical results of this study support the presence of one
cointegrating vector and two common trends. CAC index is found to be
weakly exogenous. The short run dynamics indicate short-run causal links
running both ways between FTSE and DAX.ABSTRACT FROM
AUTHORCopyright of American Economist is the property of American
Economist and its content may not be copied or emailed to multiple sites
or posted to a listserv without the copyright holder's express written
permission. However, users may print, download, or email articles for
individual use. This abstract may be abridged. No warranty is given about
the accuracy of the copy. Users should refer to the original published
version of the material for the full abstract.

Kapil gupta, Balwinder singh,An Examination of Price Discovery and

Hedging Efficiency of Indian Equity Futures Market,10th Indian
Institute of Capital Markets Conference Paper ,published in
February,2007

Present study investigates the price discovery and hedging efficiency of

NIFTY and all those stock futures whose trading started on 9th November
2001 and are continuously traded till 30th June 2006. The study observes
information asymmetry in both futures and cash market and significant
Jarque-Bera test rejects the hypothesis that returns in both markets follow
normal distribution. Both futures and cash market returns are found to be
integrated of order 1, which implies that strong long-run relationship exists
between two markets and these results are strongly supported by
predictable and stationary basis. Presence of information asymmetry and
cointegration implies that both markets are inefficient in weak form.
Moreover, Granger causality and Vector Autoregression (VAR) results
provides significant evidence that futures market leads cash market, which
implies that futures market is an efficient price discovery vehicle. On the
basis of price discovery efficiency of the futures market, hedge ratio
through EGARCH (1,1) and VAR (based on Error correction
Methodology) have been estimated, which suggests that efficient price
discovery of futures market provides good opportunities for the traders to
hedge their market risk because hedging through futures (except for
RELIANCE) help the traders to reduce portfolio variance by
approximately 90% and even more in some cases.
Paul Sarmas, CORRELATION AMONG STOCK MARKETS
UNDER DIFFERENT EXCHANGE RATE SYSTEMS, Research
in Finance, published in 2004

This study investigates the linkage between the Hong Kong stock market
and Singapore stock market and the U.S. stock market during the pre- and
post-East Asia Financial Crisis in 1997 and 1998. It uses multivariate
regression models to study the impact of Hong Kong’s fixed exchange rate
system and Singapore’s free-floating exchange rate system on their
respective stock markets. The results indicate that the exchange rate is not
a significant determinant of linkage between the U.S. and the two Asian
stock markets, but the evidence suggests that stronger post-crisis
relationships between the U.S. and the two Asian stock markets. The
evidence also supports a stronger short-run relationship between the U.S.
and Hong Kong stock markets relative to that between the U.S. and
Singapore stock markets.

Wing-Keung Wong,Aman Agarwal, Financial Integration for India

Stock Market, a Fractional Cointegration Approach, published in
2005

The Indian stock market is one of the earliest in Asia being in operation
since 1875, but remained largely outside the global integration process
until the late 1980s. A number of developing countries in concert with the
International Finance Corporation and the World Bank took steps in the
1980s to establish and revitalize their stock markets as an effective way of
mobilizing and allocation of finance. In line with the global trend, reform
of the Indian stock market began with the establishment of Securities and
Exchange Board of India in 1988. This paper empirically investigates the
long-run equilibrium relationship and short-run dynamic linkage between
the Indian stock market and the stock markets in major developed
countries (United States, United Kingdom and Japan) after 1990 by
examining the Granger causality relationship and the pairwise, multiple
and fractional cointegrations between the Indian stock market and the
stock markets from these three developed markets. We conclude that
Indian stock market is integrated with mature markets and sensitive to the
dynamics in these markets in a long run. In a short run, both US and Japan
Granger causes the Indian stock market but not vice versa. In addition, we
find that the Indian stock index and the mature stock indices form
fractionally cointegrated relationship in the long run with a common
fractional, nonstationary component and find that the Johansen method is
the best reveal their cointegration relationship

Khan Masood Ahmad, Is the Indian Stock Market Integrated with the
US and Japanese Markets? South Asia Economic Journal, published
in 2004

The paper attempts to understand the interlinkages and causal relationship

between the Nasdaq composite index in the US, the Nikkei in Japan with
that of NSE Nifty and BSE Sensex in India during the period January 1999
to August 2004, using daily closing data. The Johansen co-integration test
is applied to measure the long-term relationship between the two indices
and theGranger-causality test is used to check the short-term causal
relationship.

The analysis reveals that there is no long-term relationship of the Indian

equity market with that of the US and Japanese equity markets. Further,
Nasdaq and Nikkei have stronger causal relationship in 1999–2001 which
becomes either very weak or disappears in 2002–2004. There seems to be a
disassociation in the movements of the Nasdaq and Nikkei with that of the
Sensex and Nifty. When the stock markets have no tendency to move
together in the long-term and causal effects become weak in the short-term
then the markets are segmented and provide ample room for diversification
of investments. The recent surge of FII investments to the Indian equity
market is primarily a reflection of this trend.
Foresti, Pasquale, Testing for Granger causality between stock prices
and economic growth, published in 2006

This paper has focused on the relationship between stock market prices
and growth. A Granger-causality analysis has been carried out in order to
assess whether there is any potential predictability power of one indicator
for the other. The conclusion that can be drawn is that stock market prices
can be used in order to predict growth, but the opposite it is not true.

C.Alexander, Optimal hedging using cointegration

Cointegration is a time-series modelling methodology that has many

applications to financial markets. When spreads are mean
reverting, prices are cointegrated. Then a multivariate model will
provide further insight into the price equilibria and returns
causalities within the system. Spot–futures arbitrage, yield–curve
modelling, index tracking and spread trading are some of the
applications of cointegration that are reviewed in this paper. With
the demand for new quantitative approaches to active investment
management strategies there is considerable interest in
cointegration theory. This paper presents a model of cointegrated
international equity portfolios which is currently used for hedging
within the European, Asian and Far East countries.

Piccillo, Giulia, Foreign Exchange and Stock Market: Two Related

Markets? (September 00, 2008). Available at SSRN:
http://ssrn.com/abstract=1360621
This paper studies the relationship between the stock market and the
exchange rate in several countries. The approach taken in the first part of
this study is a linear VAR, to be compared in the following part to a
MSVAR. The data is also analyzed by Granger causality tests in both
contexts and a thorough description of the empirical results obtained is
shown. The research uncovers a spread (but not constant over time)
causality from the exchange rate and American stock market to the local
markets of the different nations studied. The non-linear, time varying
approach allows several considerations on the dynamics of the
relationship. The markets analyzed are the Japanese, the British and the
German (pre-Euro) market against the US Dollar and the US stock market.
The frequency of the data used is daily

RESEARCH METHODOLOGY

Research Design

Research Design is the plan structure and strategy of investigation

conceived so as to obtain answers to research problems. It is the
specification of the methods and procedures for acquiring the information
needed.

The research will be based on secondary data analysis. The study will
be exploratory as it aims at examining the secondary data for analyzing the
previous researches that have been done in the area of technical analysis of
stocks. The knowledge thus gained from this preliminary study forms the
basis for the further detailed Descriptive research.

Data collection process

Data needed for this study has been collected from various sources which
can be classified as Primary and Secondary data
Primary data

Primary data is the data collected by the researcher at first hand for a
specific study. For the purpose of this study the primary data has been
collected through interaction with the staff of Tradewell Securities Ltd and
also from interactive management forums (like Management paradise,
Cool Avenue, Traderji etc)

Secondary Data

Published data and the data collected in the past or other parties is
called secondary data. For the purpose of this study, the secondary data has
been collected from various sources such as Internet, magazines, Journals
etc. which are disclosed in the later part i.e. in references

Scope of the Study

The Scope of this study is limited to BSE Sensex, thus the conclusions
derived from this study may not be applicable to other exchanges in India
or other Global exchanges

Limitations of the Study

 Scope of the Study is limited to Equity Hedge Funds of India thus
the conclusions derived from this study may not be applicable to
other exchanges in India or other Global exchanges
 This study considers only Equity Hedge Funds (Other Hedge Funds
like Commodity, Real estate etc)

Sample Size
Past ten years monthly time series data of Hedge funds and Sensex

Analytical Procedures
For the purpose of the study, various tools will be considered. Some of
them are as follows
Unit Root Test and Co integration:
Empirical studies (for example, Engle and Granger, 1987) have shown that
many time
series variables are non-stationary or not integrated of order zero. The time
series
variables considered in this paper are the stock prices and fii flows. In
order to avoid a
spurious regression situation the variables in a regression model must be
stationary or
cointegrated. Therefore, in the first step, we perform unit root tests to
investigate whether
they are stationary or not. The Augmented Dickey-Fuller (ADF) unit root
test is used for
for this purpose
ADF UNIT ROOTS TEST
The tests are based on the
null hypothesis (H0): Yt is not I (0). If the calculated ADF statistics are
less than their
critical values from Fuller.s table then the null hypothesis (H0) is rejected
and the
series are stationary or not integrated of order zero
Co integration
In the second step we estimate cointegration regression using variables
having the same order of integration
Granger Causality Test
Granger causality is a technique for determining whether one time series
is useful in
forecasting another. Ordinarily, regressions reflect "mere" correlations.
A time series X is said to Granger-cause Y if it can be shown, usually
through a series of
F-tests on lagged values of X (and with lagged values of Y also known),
that those X
values provide statistically significant information on future values of Y.
The test works by first doing a regression of ÄY on lagged values of ÄY.
Once the
appropriate lag interval for Y is proved significant (t-stat or p-value),
subsequent
regressions for lagged levels of ÄX are performed and added to the
regression provided
that they 1) are significant in of themselves and 2) add explanatory power
to the model.
This can be repeated for multiple ÄX’s (with each ÄX being tested
independently of other ÄX’s, but in conjunction with the proven lag level
of ÄY). More than 1 lag level of a variable can be included in the final
regression model, provided it is statistically significant and provides
explanatory power
 RESULTS AND ANALYSIS

EMPIRICAL RESULTS:

AUGMENTED DICKEY FULLER TEST:

THE FOLLOWING TESTS ARE CONDUCTED TO TEST THE

STATIONARITY OF THE RETURNS OF THE SENSEX.
The augmented dickey fuller test for the time series values of Sensex
returns. To check that values are stationary we conduct the unit root test
and thus the result indicates the following information

ADF Test Statistic -9.899615

Null Hypothesis: tseries has a unit root

Exogenous: Constant
Lag Length: 0 (Automatic Based on AIC, MAXLAG=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -9.899615 0.000000

Test critical
values: 1% level -3.486121
5% level -2.885858
10% level -2.579823

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(tseries)
Method: Least Squares
Date: 2/27/2010 Time: 9:26:33 AM
Included observations: 119 after adjusting endpoints

Variable Coefficient Std. Error t-Statistic Prob

tseries(-1) -0.912694 0.092195 -9.899615 0.000000

78.88344
C 94.275632 9 1.195126 0.234455

Mean dependent
R-squared 0.455820 var 2.849748
Adjusted R-
squared 0.183730 S.D. dependent var 1153.567623
Akaike info
S.E. of regression 854.599100 criterion 16.355806
85449735.78455
Sum squared resid 0 Schwarz criterion 16.402514
Log likelihood -971.170451 F-statistic 98.002377
Durbin-Watson
stat 2.019055 Prob(F-statistic) 0.000000

Here the null hypothesis is rejected since the t-statistics value is -9.899615,
which is less than the critical values at 5% and 1% significance level.

Thus we can conclude that, the values are stationary and the trend is
deterministic

TEST FOR THE STATIONARITY OF THE HEDGE FUNDS

THE FOLLOWING TESTS ARE CONDUCTED TO TEST

THE
STATIONARITY OF THE HEDGE FUND RETURNS

The augmented dickey fuller test for the time series values of Hedge Fund
returns. To check the values are stationary we conduct the unit root test
and thus the result indicates the following information
ADF Test Statistic -3.831425
Null Hypothesis: tseries has a unit root
Exogenous: Constant
Lag Length: 3 (Automatic Based on AIC, MAXLAG=10)

t-Statistic Prob.*

Augmented Dickey-Fuller test statistic -3.831425 0.003476

Test critical
values: 1% level -3.487607
5% level -2.886503
10% level -2.580168

*MacKinnon (1996) one-sided p-values.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(tseries)
Method: Least Squares
Date: 2/27/2010 Time: 9:19:51 AM
Included observations: 116 after adjusting endpoints

Std.
Variable Coefficient Error t-Statistic Prob

0.14346
tseries(-1) -0.549659 1 -3.831425 0.000212
0.13259
D(tseries(-1)) -0.257125 6 -1.939160 0.055020
0.11848
D(tseries(-2)) -0.127143 0 -1.073113 0.285548
0.09254
D(tseries(-3)) -0.179965 7 -1.944576 0.054356
0.87412
C 0.755349 1 0.864124 0.389383

Mean dependent
R-squared 0.424102 var 0.095259
Adjusted R-
squared -0.036617 S.D. dependent var 12.029031
Akaike info
S.E. of regression 9.291608 criterion 7.338247
9583.07171
Sum squared resid 9 Schwarz criterion 7.456936
Log likelihood -420.618339 F-statistic 20.435610
Durbin-Watson
stat 2.019349 Prob(F-statistic) 0.000000

Here the null hypothesis is rejected since the t-statistics value is --3.831425,
which is less
than the critical values at 5% and 1% significance level.

Thus we can conclude that, the values are stationary and the trend is
deterministic

JOHANSEN COINTEGRATION TEST

The cointegration test, suggests the likelihood of the existence of the other
model due to the initial model.Thus calculating the likelihood ratio will
show the probability of the regression of other equation with initial
equation.

Date: 27/02/10 Time: 13:54

Included observations: 116
Test assumption:
Linear deterministic trend in the data

Series: HEDGE SENSEX

Lags interval: No lags

5 Percent 1 Percent
Lkelyhood Critical Critical Hypothesized
Eigenvalue Ratio (LR) Value Value No. of CE(s)
0
.53 87.54 15.41 20.04 None **
0
6.65
.412 30.89 3.76 At most 1 **

*(**) denotes rejection of the hypothesis at 5%(1%) significance Level L.R. test
indicates 2 cointegrating equation(s) at 5% significance level
Here, the likelihood ratio is 87.54 which is greater than critical values at 5
%
significance value. Hence by looking at the table we can say that
rejection of the
hypothesis at 5%(1%) significance level

GRANGER CAUSALITY TEST

Pairwise Granger Causality Tests

Date: 27/02/10 Time: 17:57
Sample:116
Lags: 1

Null Hypothesis: Obs F-Statistic Probability

SENSEX does not Granger Cause Hhedge Funds 116 2.10852 0.35191
Hedge Funds does not Granger Cause SENSEX 1.96900 0.21037

HYPOTHESIS:

We took the null hypothesis, that Sensex Granger cause Hedge Funds and
vice versa,
In case 1:
Sensex on Granger cause to Hedge Funds
Here, f-statistic value is 2.10852 which is more than the critical value of
1.7 and 1.58 at 5 % and 1 % significance level respectively.
Thus we accept the null hypothesis and can say Sensex causes the Hedge
Funds
On the other hand analyzing the impact of Hedge Funds on Sensex for
daily returns we see that
F-statistic value is 1.96900 which is more than the critical value of 1.7 and
1.58 at 5 %
and 1 % significance level respectively.
Thus we again accept the null hypothesis and can say Hedge Funds has
cause on Sensex returns.
Now following is the finding for grangers causality test.:
There is causal relation between Hedge Funds and Sensex returns.

DISCUSSION & IMPLICATION

 It is found that the times series values of Hedge Funds

and Sensex returns are Stationary and Deterministic

 It is found that the Sensex returns and Hedge Fund

returns are cointigrated from the past one year Time
series data

 There exists a Causal relation between Sensex and Hedge

Funds
 CONCLUSION & RECOMMENDATION

The causal relationship was tested between the BSE index and
Hedge Funds . Hedge Funds is included in the model as an additional
variable, to examine whether Hedge Funds Added more Sensitivity to
Sensex In this highly volatile market conditions. Hedge Funds are one of
the aim instruments on which market can bet on, not only to reduce
volatility and risk but also to preserve capital and deliver positive returns
under all market conditions.
After looking at the following testing , we found the times series
for the year 2009 for Hedge Fund Returns and Sensex returns, which
shows both the trends are deterministic, and the values are stationary,
these trends were tested for cointigration, and were found that the
multicollinearity exits as the likelihood ratio was high . The causality test
proved that null hypothesis doesnt exits and thus proved there is a
causal relation between the Hedge Fund returns and Sensex returns.

Hence it is concluded that Hedge Funds added more Sensitivity to

Sensex

RECOMMENDATION

While making an investment decision, it is recommended that both Hedge

Funds and Sensex are to be considered to take both long and short
positions, use arbitrage, buy and sell undervalued securities, trade options
or bonds, and invest in almost any opportunity in any market where it
foresees impressive gains at reduced risk

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 GLOSSARY

Acceptance region: The set of values of a test statistic for which the null
hypothesis is accepted (is not rejected).
Adjusted R2( ): A modified version of R2 that does not necessarily
increase when a new regressor is added to the regression.
Akaike information criterion: See information criterion.
Alternative hypothesis: The hypothesis that is assumed to be true if the
null hypothesis is false. The alternative hypothesis is often denoted H1.
Asymptotic distribution: The approximate sampling distribution of a
random variable computed using a large sample. For example, the
asymptotic distribution of the sample average is normal.
Asymptotic normal distribution: A normal distribution that
approximates the sampling distribution of a statistic computed using a
large sample.
Attrition: The loss of subjects from a study after assignment to the
treatment or control group.
Augmented Dickey-Fuller (ADF) test: A regressionbased test for a unit
root in an AR(p) model.
Autocorrelation: The correlation between a time series variable and its
lagged value.The jth autocorrelation of Y is the correlation between Yt and
Yt2j.
Autocovariance: The covariance between a time series variable and its
lagged value.The jth autocovariance of Y is the covariance between Yt and
Yt2j.
Autoregression: A linear regression model that relates a time series
variable to its past (that is, lagged) values. An autoregression with p lagged
values as regressors is denoted AR(p). Autoregressive conditional
heteroskedasticity
(ARCH): A time series model of conditional heteroskedasticity. R2
Autoregressive distributed lag model: A linear regression model in
which the time series variable Yt is expressed as a function of lags of Yt
and of another variable, Xt.The model is denoted ADL(p,q), where p
denotes the number of lags of Yt and q denotes the number of lags of Xt.
Average causal effect: The population average of the individual causal
effects in a heterogeneous population. Also called the average treatment
effect..
Binary variable: A variable that is either 0 or 1.A binary variable is used
to indicate a binary outcome. For example,X is a binary (or indicator, or
dummy) variable for a person’s gender if X 5 1 if the person is female and
X 5 0 if the person is male. mˆY mˆY mˆY
Bivariate normal distribution: A generalization of the normal
distribution to describe the joint distribution of two random variables.
Break date: The date of a discrete change in population time series
regression coefficient(s).
Causal effect: The expected effect of a given intervention or treatment as
measured in an ideal randomized controlled experiment.
Chi-squared distribution: The distribution of the sum of m squared
independent standard normal random variables.The parameter m is called
the degrees of the freedom of the chi-squared distribution.
Chow test: A test for a break in a time series regression at a known break
date.
Coefficient of determination: See R2.
Cointegration: When two or more time series variables share a common
stochastic trend.
Common trend: A trend shared by two or more time series.
Conditional distribution: The probability distribution of one random
variable given that another random variable takes on a particular value.
Conditional expectation: The expected value of one random value given
that another random variable takes on a particular value.
Conditional heteroskedasticity: The variance, usually of an error term,
depends on other variables.
Conditional mean: The mean of a conditional distribution; see conditional
expectation.
Conditional mean independence: The conditional expectation of the
regression error ui, given the regressors, depends on some but not all of the
regressors.
Conditional variance: The variance of a conditional distribution.
Confidence interval (or confidence set): An interval (or set) that contains
the true value of a population parameter with a prespecified probability
when computed over repeated samples.
Confidence level: The prespecified probability that a confidence interval
(or set) contains the true value of the parameter.
Consistency: Means that an estimator is consistent. See consistent
estimator.
Consistent estimator: An estimator that converges in probability to the
parameter that it is estimating.
Constant regressor: The regressor associated with the regression
intercept; this regressor is always equal to 1.
Constant term: The regression intercept.
Continuous random variable: A random variable that can take on a
continuum of values.
Control group: The group that does not receive the treatment or
intervention in an experiment.
Control variable: Another term for a regressor; more specifically, a
regressor that controls for one of the factors that determine the dependent
variable.
Convergence in distribution: When a sequence of distributions
converges to a limit; a precise definition is given in Section 17.2.
Convergence in probability: When a sequence of random variables
converges to a specific value; for example, when the sample average
becomes close to the population mean as the sample size increases; see
Key Concept 2.6 and Section 17.2.
Correlation: A unit-free measure of the extent to which two random
variables move, or vary, together.The correlation (or correlation
coefficient) between X and Y is sXY/sXsY and is denoted corr(X,Y).
Correlation coefficient: See correlation.
Covariance: A measure of the extent to which two random variables move
together.The covariance between X and Y is the expected value E[(X 2
mX)(Y 2 mY)], and is denoted by cov(X,Y) or by sXY.
Covariance matrix: A matrix composed of the variances and covariances
of a vector of random variables.
Critical value: The value of a test statistic for which the test just rejects
the null hypothesis at the given significance level.
Dependent variable: The variable to be explained in a regression or other
statistical model; the variable appearing on the left-hand side in a
regression.
Deterministic trend: A persistent long-term movement of a variable over
time that can be represented as a nonrandom function of time.
Dickey-Fuller test: A method for testing for a unit root in a first order
autoregression [AR(1)].
Differences estimator: An estimator of the causal effect constructed as the
difference in the sample average outcomes between the treatment and
control groups.
Differences-in-differences estimator: The average change in Y for those
in the treatment group, minus the average change in Y for those in the
control group.
Discrete random variable: A random variable that takes on discrete
values.
Distributed lag model: A regression model in which the regressors are
current and lagged values of X.
Dummy variable: See binary variable.
Dummy variable trap: A problem caused by including a full set of binary
variables in a regression together with a constant regressor (intercept),
leading to perfect multicollinearity.
Dynamic causal effect: The causal effect of one variable on current and
future values of another variable.
Dynamic multiplier: The h-period dynamic multiplier is the effect of a
unit change in the time series variable Xt on Yt+h.
Endogenous variable: A variable that is correlated with the error term.
Error term: The difference between Y and the population regression
function, denoted by u in this textbook.

Errors-in-variables bias: The bias in an estimator of a regression

coefficient that arises from measurement errors in the regressors.
Estimate: The numerical value of an estimator computed from data in a
specific sample.
Estimator: A function of a sample of data to be drawn randomly from a
population. An estimator is a procedure for using sample data to compute
an educated guess of the value of a population parameter, such as the
population mean.
Exact distribution: The exact probability distribution of a random
variable.
Exact identification: When the number of instrumental variables equals
the number of endogenous regressors.
Exogenous variable: A variable that is uncorrelated with the regression
error term.
Expected value: The long-run average value of a random variable over
many repeated trials or occurrences. It is the probability-weighted average
of all possible values that the random variable can take on.The expected
value of Y is denoted E(Y) and is also called the expectation of Y.
Experimental data: Data obtained from an experiment designed to
evaluate a treatment or policy or to investigate a causal effect.
Experimental effect: When experimental subjects change their behavior
because they are part of an experiment.
Explained sum of squares (ESS): The sum of squared deviations of the
predicted values of Yi, ,from their average; see Equation (4.14).
Explanatory variable: See regressor.
External validity: Inferences and conclusions from a statistical study are
externally valid if they can be generalized from the population and the
setting studied to other populations and settings.
F-statistic: A statistic used to a test joint hypothesis concerning more than
one of the regression coefficients.
Fm,n distribution: The distribution of a ratio of independent random
variables, where the numerator is a chi-squared random variable with m
degrees of freedom, divided by m, and the denominator is a chi-squared
random variable with n degrees of freedom divided by n.
Fm,` distribution: The distribution of a random variable with a chi-
squared distribution with m degrees of freedom, divided by m.
Feasible GLS: A version of the generalized least squares (GLS) estimator
that uses an estimator of the conditional variance of the regression errors
and covariance between the regression errors at different observations.
Feasible WLS: A version of the weighted least squares (WLS) estimator
that uses an estimator of the conditional variance of the regression errors.
First difference: The first difference of a time series variable Yt is Yt 2
Yt21, denoted DYt.
First-stage regression: The regression of an included endogenous variable
on the included exogenous variables, if any, and the instrumental
variable(s) in two stage least squares.
Fitted values: See predicted values.
Fixed effects: Binary variables indicating the entity or time period in a
panel data regression.
Fixed effects regression model: A panel data regression that includes
entity fixed effects. ˆYi
Forecast error: The difference between the value of the variable that
actually occurs and its forecasted value.
Forecast interval: An interval that contains the future value of a time
series variable with a prespecified probability.
Functional form misspecification: When the form of the estimated
regression function does not match the form of the population regression
function; for example, when a linear specification is used but the true
population regression function is quadratic.
GARCH: See generalized autoregressive conditional heteroskedasticity.
Gauss-Markov theorem: Mathematical result stating that, under certain
conditions, the OLS estimator is the best linear unbiased estimator of the
regression coefficients conditional on the values of the regressors.
Generalized autoregressive conditional heteroskedasticity: A time
series model for conditional heteroskedasticity.
Generalized least squares (GLS): A generalization of OLS that is
appropriate when the regression errors have a known form of
heteroskedasticity (in which case GLS is also referred to as weighted least
squares, WLS) or a known form of serial correlation.
Generalized method of moments: A method for estimating parameters by
fitting sample moments to population moments that are functions of the
unknown parameters. Instrumental variables estimators are an important
special case.
GMM: See generalized method of moments.
Granger causality test: A procedure for testing whether current and
lagged values of one time series help predict future values of another time
series.
HAC standard errors: See heteroskedasticity- and autocorrelation-
consistent (HAC) standard errors.
(HAC) standard errors: Standard errors for OLS estimators that are
consistent whether or not the regression errors are heteroskedastic and
autocorrelated.
Hypothesis test: A procedure for using sample evidence to help determine
if a specific hypothesis about a population is true or false.
i.i.d.: Independently and indentically distributed. I(0), I(1), and I(2): See
order of integration.
Identically distributed: When two or more random variables have the
same distribution.
Impact effect: The contemporaneous, or immediate, effect of a unit
change in the time series variable Xt on Yt.
Included endogenous variables: Regressors that are correlated with the
error term (usually in the context of instrumental variable regression).
Included exogenous variables: Regressors that are uncorrelated with the
error term (usually in the context of instrumental variable regression).
Independence: When knowing the value of one random variable provides
no information about the value of another random variable.Two random
variables are independent if their joint distribution is the product of their
marginal distributions.
Indicator variable: See binary variable.
Information criterion: A statistic used to estimate the number of lagged
variables to include in an autoregression or a distributed lag model.
Leading examples are the Akaike information criterion (AIC) and the
Bayes information criterion (BIC).
Instrument: See instrumental variable.
Instrumental variable: A variable that is correlated with an endogenous
regressor (instrument relevance) and is uncorrelated with the regression
error (instrument exogeneity).
Lags: The value of a time series variable in a previous time period.The jth
lag of Yt is Yt2j.
Linear probability model: A regression model in which Y is a binary
variable.
Linear regression function: A regression function with a constant slope.
Local average treatment effect: A weighted average treatment effect
estimated, for example, by TSLS.
Log-linear model: A nonlinear regression function in which the
dependent variable is ln(Y) and the independent variable is X.
Logarithm: A mathematical function defined for a positive argument; its
slope is always positive but tends to zero.The natural logarithm is the
inverse of the exponential function, that is, X 5 ln(eX).
Logit regression: A nonlinear regression model for a binary dependent
variable in which the population regression function is modeled using the
cumulative logistic distribution function.
Maximum likelihood estimator (MLE): An estimator of unknown
parameters that is obtained by maximizing the likelihood function; see
Appendix 11.2.
Mean: The expected value of a random variable.The mean of Y is denoted
mY.
95% confidence set: A confidence set with a 95% confidence level; see
confidence interval.
Nonlinear least squares: The analog of OLS that applies when the
regression function is a nonlinear function of the unknown parameters.
Nonlinear least squares estimator: The estimator obtained by
minimizing the sum of squared residuals when the regression function is
nonlinear in the parameters.
Nonstationary: When the joint distribution of a time series variable and
its lags changes over time.
Normal distribution: A commonly used bell-shaped distribution of a
continuous random variable.
Null hypothesis: The hypothesis being tested in a hypothesis test, often
denoted by H0.
Observation number: The unique identifier assigned to each entity in a
data set.
Observational data: Data based on observing, or measuring, actual
behavior outside an experimental setting. OLS estimator. See ordinary
least squares estimator.
OLS regression line: The regression line with population coefficients
replaced by the OLS estimators.
OLS residual: The difference between Yi and the OLS regression line,
denoted by in this textbook.
Omitted variables bias: The bias in an estimator that arises because a
variable that is a determinant of Y and is correlated with a regressor has
been omitted from the regression.
p-value: The probability of drawing a statistic at least as adverse to the
null hypothesis as the one actually computed, assuming the null hypothesis
is correct. Also called the marginal significance probability, the p-value is
the smallest significance level at which the null hypothesis can be
rejected.
Polynomial regression model: A nonlinear regression function that
includes X, X2, . . . and Xr as regressors, where r is an integer. uˆi
Population: The group of entities—such as people, companies, or school
districts—being studied.
Predicted value: The value of Yi that is predicted by the OLS regression
line, denoted by in this textbook.
Probability: The proportion of the time that an outcome (or event) will
occur in the long run.
Probit regression: A nonlinear regression model for a binary dependent
variable in which the population regression function is modeled using the
cumulative standard normal distribution function.
Regression specification: A description of a regression that includes the
set of regressors and any nonlinear transformation that has been applied.
Rejection region: The set of values of a test statistic for which the test
rejects the null hypothesis.
Restricted regression: Aregression in which the coefficients are restricted
to satisfy some condition. For example, when computing the
homoskedasticityonly F-statistic, this is the regression with coefficients
restricted to satisfy the null hypothesis.
Root mean squared forecast error: The square root of the mean of the
squared forecast error.
Sample correlation: An estimator of the correlation between two random
variables.
Sample covariance: An estimator of the covariance between two random
variables.
Sample selection bias: The bias in an estimator of a regression coefficient
that arises when a selection process influences the availability of data and
that process is related to the dependent variable.This induces correlation
between one or more regressors and the regression error.
Sample standard deviation: An estimator of the standard deviation of a
random variable.
Sample variance: An estimator of the variance of a random variable.
Sampling distribution: The distribution of a statistic over all possible
samples; the distribution arising from repeatedly evaluating the statistic
using a R2 series of randomly drawn samples from the same population.
Scatterplot: A plot of n observations on Xi and Yi, in which each
observation is represented by the point (Xi,Yi).
Serial correlation: See autocorrelation.
Serially uncorrelated: A time series variable with all autocorrelations
equal to zero.
Significance level: The prespecified rejection probability of a statistical