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Options on Hedge Funds under the High Water Mark Rule

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Listed:
  • Marc N. Atlan

    (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique)

  • Hélyette Geman

    (ESSEC Business School)

  • Marc Yor

    (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - UPMC - Université Pierre et Marie Curie - Paris 6 - UPD7 - Université Paris Diderot - Paris 7 - CNRS - Centre National de la Recherche Scientifique)

Abstract

The rapidly growing hedge fund industry has provided individual and institutional investors with new investment vehicles and styles of management. It has also brought forward a new form of performance contract: hedge fund managers receive incentive fees which are typically a fraction of the fund net asset value (NAV) above its starting level - a rule known as high water mark. Options on hedge funds are becoming increasingly popular, in particular because they allow investors with limited capital to get exposure to this new asset class. The goal of the paper is to propose a valuation of plain-vanilla options on hedge funds which accounts for the high water market rule. Mathematically, this valuation leads to an interesting use of local times of Brownian motion. Option prices are numerically computed by inversion of their Laplace transforms.

Suggested Citation

  • Marc N. Atlan & Hélyette Geman & Marc Yor, 2006. "Options on Hedge Funds under the High Water Mark Rule," Working Papers hal-00012382, HAL.
    • Handle: RePEc:hal:wpaper:hal-00012382
    Note: View the original document on HAL open archive server: https://hal.science/hal-00012382v4
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    References listed on IDEAS

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    2. Amin, Gaurav S. & Kat, Harry M., 2003. "Hedge Fund Performance 1990–2000: Do the “Money Machines†Really Add Value?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(2), pages 251-274, June.
    3. Helyette Geman & Cécile Kharoubi, 2003. "Hedge Funds Revisited : Distributional Characteristics, Dependence Structure and Diversification," Post-Print halshs-00144363, HAL.
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    7. repec:dau:papers:123456789/1385 is not listed on IDEAS
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