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Portfolio optimization in hedge funds by OGARCH and Markov Switching Model

Author

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  • Luo, Cuicui
  • Seco, Luis
  • Wu, Lin-Liang Bill

Abstract

This paper investigates and compares the performances of the optimal portfolio selected by using the Orthogonal GARCH (OGARCH) Model, Markov Switching Model and the Exponentially Weighted Moving Average (EWMA) Model in a fund of hedge funds. These models are used to calibrate the returns of four HFRX indices from which the optimal portfolio is constructed using the Mean-Variance method. The performance of each optimal portfolio is compared in an out-of-sample period and it is observed that overall, OGARCH gives the best-performed optimal portfolio with the highest Sharpe ratio and the lowest risk. Moreover, a sensitivity analysis for the parameters of OGARCH is performed and it shows that the asset weights in the optimal portfolios selected by OGARCH are very sensitive to slight changes in the input parameters.

Suggested Citation

  • Luo, Cuicui & Seco, Luis & Wu, Lin-Liang Bill, 2015. "Portfolio optimization in hedge funds by OGARCH and Markov Switching Model," Omega, Elsevier, vol. 57(PA), pages 34-39.
    • Handle: RePEc:eee:jomega:v:57:y:2015:i:pa:p:34-39
    DOI: 10.1016/j.omega.2015.01.021
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    7. Magni, Carlo Alberto & Marchioni, Andrea & Baschieri, Davide, 2023. "The Attribution Matrix and the joint use of Finite Change Sensitivity Index and Residual Income for value-based performance measurement," European Journal of Operational Research, Elsevier, vol. 306(2), pages 872-892.
    8. Abdul Aziz, Nor Syahilla & Vrontos, Spyridon & M. Hasim, Haslifah, 2019. "Evaluation of multivariate GARCH models in an optimal asset allocation framework," The North American Journal of Economics and Finance, Elsevier, vol. 47(C), pages 568-596.

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