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Regular(Ized) Hedge Fund Clones

  • Daniel Giamouridis
  • Sandra Paterlini

Abstract This article addresses the problem of portfolio construction in the context of efficient hedge fund investments replication. We propose a modification to the standard Sharpe "style analysis" by introducing a constraint on the asset weights 1-norm and 2-norm. This constraint regularizes the optimization problem, allows efficient selection of relevant factor's and has significant effects on the stability of the resulting asset mix and the risk-return characteristics of the replicating portfolio. The empirical results suggest that the norm-constrained replicating portfolios exhibit significant correlations with their benchmarks, often higher than 0.9; have a fraction, which is about half to two-thirds, of active positions relative to those determined through the standard method; and are obtained with turnover, which is in some instances about one-fourth of that for the standard method. Copyright (c) 2010 The Southern Finance Association and the Southwestern Finance Association.

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Article provided by Southern Finance Association & Southwestern Finance Association in its journal Journal of Financial Research.

Volume (Year): 33 (2010)
Issue (Month): 3 ()
Pages: 223-247

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Handle: RePEc:bla:jfnres:v:33:y:2010:i:3:p:223-247
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