The necessity to correct hedge fund returns: empirical evidence and correction method

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The necessity to correct hedge fund returns: empirical evidence and correction method

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Georges Gallais-Hamonno (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans)
Huyen Nguyen-Thi-Thanh () (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans, Groupe Sup de Co La Rochelle - CEREGE - Groupe Sup de Co La Rochelle - CEREGE)

Abstract

We study two principal mechanisms suggested in the literature to correct the serial correlationin hedge fund returns and the impact of this correction on financial characteristics of their returnsas well as on their risk level and on their performances. The methods of Geltner (1993), its extensionby Okunev & White (2003) and of Getmansky, Lo & Makarov (2004) are realized on a sampleof 54 hedge fund indexes. The results show that the unsmoothing leaves the mean unchangedbut increases significantly the risk level of hedge funds, whether the risk is measured in terms ofthe return standard-deviation or the modified Value-At-Risk. Funds’ performances, measured bytraditional Sharpe ratio and Omega index decline considerably. By contrast, funds’ rankings afterthe unsmoothing unexpectedly change slightly. However, some notable modifications in ranks ofseveral funds are observed. The necessary transparency of the management practice requires thatsuch a correction must be systematically done.

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Paper provided by HAL in its series Working Papers with number halshs-00184470_v1.

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Date of creation: Oct 2007
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David M. Geltner, 1993. "Estimating Market Values from Appraised Values without Assuming an Efficient Market," Journal of Real Estate Research, American Real Estate Society, vol. 8(3), pages 325-346. [Downloadable!]
Getmansky, Mila & Lo, Andrew W. & Makarov, Igor, 2004. "An econometric model of serial correlation and illiquidity in hedge fund returns," Journal of Financial Economics, Elsevier, vol. 74(3), pages 529-609, December. [Downloadable!] (restricted)
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- Getmansky, Mila & Lo, Andrew & Makarov, Igor, 2003. "An Econometric Model of Serial Correlation and Illiquidity In Hedge Fund Returns," Working papers 4288-03, Massachusetts Institute of Technology (MIT), Sloan School of Management. [Downloadable!]
- Mila Getmansky & Andrew W. Lo & Igor Makarov, 2003. "An Econometric Model of Serial Correlation and Illiquidity in Hedge Fund Returns," NBER Working Papers 9571, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
William F. Sharpe, 1965. "Mutual Fund Performance," Journal of Business, University of Chicago Press, vol. 39, pages 119. [Downloadable!]

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