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Generating a Target Payoff Distribution with the Cheapest Dynamic Portfolio: An Application to Hedge Fund Replication

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  • Akihiko Takahashi

    (Faculty of Economics, University of Tokyo)

  • Kyo Yamamoto

    (GCI Asset Management, Inc.)

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    Abstract

    This paper provides a new method to construct a dynamic optimal portfolio for asset management. This method generates a target payoff distribution using the cheapest dynamic trading strategy. As a practical example, the method is applied to hedge fund replication. This dynamic portfolio strategy is regarded as an extension of a hedge fund replication methodology that was developed by Kat and Palaro (2005a, b) and Papageorgiou, Remillard and Hocquard (2008) to address multiple trading assets with both long and short positions. Empirical analyses show that such an extension significantly improves the performance of replication in practice.

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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2009/2009cf624.pdf
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    Bibliographic Info

    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-624.

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    Length: 39 pages
    Date of creation: Jun 2009
    Date of revision:
    Handle: RePEc:tky:fseres:2009cf624

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    1. Fung, William & Hsieh, David A, 1997. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 275-302.
    2. Fung, William & Hsieh, David A, 2001. "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 313-41.
    3. Jakša Cvitanić & Vassilis Polimenis & Fernando Zapatero, 2008. "Optimal portfolio allocation with higher moments," Annals of Finance, Springer, vol. 4(1), pages 1-28, January.
    4. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
    5. Akihiko Takahashi & Nakahiro Yoshida, 2004. "An Asymptotic Expansion Scheme for Optimal Investment Problems," Statistical Inference for Stochastic Processes, Springer, vol. 7(2), pages 153-188, May.
    6. 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(02), pages 251-274, June.
    7. Akihiko Takahashi & Kyo Yamamoto, 2010. "A New Hedge Fund Replication Method with the Dynamic Optimal Portfolio," CIRJE F-Series CIRJE-F-726, CIRJE, Faculty of Economics, University of Tokyo.
    8. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
    9. Akihiko Takahashi & Kyo Yamamoto, 2010. "A New Hedge Fund Replication Method With The Dynamic Optimal Portfolio," CARF F-Series CARF-F-211, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    10. Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 63-98.
    11. Dybvig, Philip H, 1988. "Distributional Analysis of Portfolio Choice," The Journal of Business, University of Chicago Press, vol. 61(3), pages 369-93, July.
    12. Fung, William & Hsieh, David A., 2000. "Performance Characteristics of Hedge Funds and Commodity Funds: Natural vs. Spurious Biases," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(03), pages 291-307, September.
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