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Risk and performance estimation in hedge funds revisited: Evidence from errors in variables

  • Coën, Alain
  • Hübner, Georges

This paper revisits the performance of hedge funds in the presence of errors in variables. To reduce the bias induced by measurement error, we introduce an estimator based on cross sample moments of orders three and four. This Higher Moment Estimation (HME) technique has significant consequences on the measure of factor loadings and the estimation of abnormal performance. Large changes in alphas can be attributed to measurement errors at the level of explanatory variables, while we emphasize some shifts in the economic contents of the equity risk premiums by switching from OLS to HME.

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Article provided by Elsevier in its journal Journal of Empirical Finance.

Volume (Year): 16 (2009)
Issue (Month): 1 (January)
Pages: 112-125

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Handle: RePEc:eee:empfin:v:16:y:2009:i:1:p:112-125
Contact details of provider: Web page: http://www.elsevier.com/locate/jempfin

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  1. Dagenais, Marcel G. & Dagenais, Denyse L., 1997. "Higher moment estimators for linear regression models with errors in the variables," Journal of Econometrics, Elsevier, vol. 76(1-2), pages 193-221.
  2. Erickson, Timothy & Whited, Toni M., 2002. "Two-Step Gmm Estimation Of The Errors-In-Variables Model Using High-Order Moments," Econometric Theory, Cambridge University Press, vol. 18(03), pages 776-799, June.
  3. Hausman, Jerry A, 1978. "Specification Tests in Econometrics," Econometrica, Econometric Society, vol. 46(6), pages 1251-71, November.
  4. Klepper, Steven & Leamer, Edward E, 1984. "Consistent Sets of Estimates for Regressions with Errors in All Variables," Econometrica, Econometric Society, vol. 52(1), pages 163-83, January.
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  8. Chen, Yong & Liang, Bing, 2007. "Do Market Timing Hedge Funds Time the Market?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(04), pages 827-856, December.
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  12. 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.
  13. Edward Leamer, 1906. "Errors in Variables in Linear Systems," UCLA Economics Working Papers 406, UCLA Department of Economics.
  14. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  15. Carmichael, Benoît & Coën, Alain, 2008. "Asset pricing models with errors-in-variables," Journal of Empirical Finance, Elsevier, vol. 15(4), pages 778-788, September.
  16. Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 63-98.
  17. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
  18. Fung, William & Hsieh, David A & Naik, Narayan & Ramadorai, Tarun, 2006. "Hedge Funds: Performance, Risk and Capital Formation," CEPR Discussion Papers 5565, C.E.P.R. Discussion Papers.
  19. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, vol. 4(2), pages 129-176, March.
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