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Optimal Hedge Fund Allocation

Optimal Hedge Fund Allocation

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Published by: http://besthedgefund.blogspot.com on Dec 04, 2010
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Optimal Hedge Fund Allocationwith Improved Estimates forCoskewness andCokurtosis Parameters
September 2010
An EDHEC-Risk Institute Publication
Institute
with the support o 
 
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This research was supported by Newedge Prime Brokerage, the sponsor of the "Advanced Modelling for Alternative Investments"research chair at EDHEC-Risk Institute.Printed in France, September 2010. Copyright© EDHEC 2010.The opinions expressed in this study are those of the authors and do not necessarily reflect those of EDHEC Business School.The authors can be contacted at research@edhec-risk.com.
Abstract ................................................................................................................... 51. Introduction ...................................................................................................... 72. Improved Estimators for Hedge Fund Return Covariance,
 
Coskewness, and Cokurtosis Parameters ......................................................... 113. Empirical Analysis ...........................................................................................154. Conclusion .........................................................................................................215. References .........................................................................................................23About EDHEC-Risk Institute ...............................................................................25About Newedge .....................................................................................................29EDHEC-Risk Institute Publications and Position Papers (2007-2010) .........33
Table of Contents
 
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An EDHEC-Risk Institute Publication
Optimal Hedge Fund Allocation with Improved Estimates for Coskewness and Cokurtosis Parameters -
September 2010
The present document, which representsthe second-year publication rom the“Advanced Modelling or AlternativeInvestments” research chair at EDHEC-RiskInstitute, supported by Newedge PrimeBrokerage, is a perect illustration o thepurpose behind the research chair, namelyto expand the rontiers in alternativeinvestment modelling techniques byenhancing the understanding o thedynamic and non-linear relationshipbetween alternative investment returnsand the returns on underlying undamentalsystematic actors, and analysing theimplications or managing portolios thatinclude alternative investments.It is clear that since hedge und returnsare not normally distributed, mean-variance optimisation techniques, whichwould lead to substantial welare lossesrom the investor’s perspective, need tobe replaced by optimisation proceduresincorporating higher-order momentsand comoments. In this context, optimalportolio decisions involving hedge undstyle allocation require not only estimatesor covariance parameters but alsoestimates or coskewness and cokurtosisparameters.The current publication presents anapplication o the improved estimatorsor higher-order comoment parameters,recently introduced by Martellini andZiemann (2010), in the context o hedge und portolio optimisation.The authors ind that the use o theseenhanced estimates generates signiicantimprovement or investors in hedgeunds, and that it is only when improvedestimators are used that portolio selectionwith higher-order moments consistentlydominates mean-variance analysis roman out-o-sample perspective.As the authors point out, the results haveimportant potential implications or hedgeund investors and hedge und o undsmanagers who routinely use portoliooptimisation procedures incorporatinghigher moments.We would particularly like to thank theauthors, Lionel Martellini, ScientiicDirector o EDHEC-Risk Institute, andAsmerilda Hitaj and Giovanni Zambrunoo the University o Milano – Bicocca, orthe quality o their research.We would also like to thank NewedgePrime Brokerage or their generous supporto our research and the publishing teamo Laurent Ringelstein and John Penuelor their role in producing the currentdocument.Wishing you an agreeable and inormativeread,
Noël Amenc
Proessor o FinanceDirector o EDHEC-Risk Institute
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