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Hedge Fund Performance Evaluation under the Stochastic Discount Factor Framework

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  • Li, Haitao
  • Xu, Yuewu
  • Zhang, Xiaoyan

Abstract

We study hedge fund performance evaluation under the stochastic discount factor framework of Farnsworth, Ferson, Jackson, and Todd (FFJT). To accommodate dynamic trading strategies and derivatives used by hedge funds, we extend FFJT’s approach by considering models with option and time-averaged risk factors and incorporating option returns in model estimation. A wide range of models yield similar conclusions on the performance of simulated long/short equity hedge funds. We apply these models to 2,315 actual long/short equity funds from the Lipper TASS database and find that a small portion of these funds can outperform the market.

Suggested Citation

  • Li, Haitao & Xu, Yuewu & Zhang, Xiaoyan, 2016. "Hedge Fund Performance Evaluation under the Stochastic Discount Factor Framework," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 51(1), pages 231-257, February.
    • Handle: RePEc:cup:jfinqa:v:51:y:2016:i:01:p:231-257_00
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    Cited by:

    1. Newton, David & Platanakis, Emmanouil & Stafylas, Dimitrios & Sutcliffe, Charles & Ye, Xiaoxia, 2021. "Hedge fund strategies, performance &diversification: A portfolio theory & stochastic discount factor approach," The British Accounting Review, Elsevier, vol. 53(5).
    2. Almeida, Caio & Ardison, Kym & Garcia, René, 2020. "Nonparametric assessment of hedge fund performance," Journal of Econometrics, Elsevier, vol. 214(2), pages 349-378.
    3. Fletcher, Jonathan, 2021. "Evaluating the performance of U.S. international equity closed-end funds," Journal of Multinational Financial Management, Elsevier, vol. 60(C).

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