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Evaluating Hedge Funds with Pooled Benchmarks

Author

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  • Michael S. O’Doherty

    () (Department of Finance, Trulaske College of Business, University of Missouri, Columbia, Missouri 65211)

  • N. E. Savin

    () (Department of Economics, Tippie College of Business, University of Iowa, Iowa City, Iowa 52242)

  • Ashish Tiwari

    () (Department of Finance, Tippie College of Business, University of Iowa, Iowa City, Iowa 52242)

Abstract

The evaluation of hedge fund performance is challenging given the flexible nature of hedge funds’ strategies and their lack of operational transparency. As a result, inference about skill is inevitably contaminated by the error in the benchmark model. To address this concern, we propose a model pooling approach to develop a fund-specific benchmark obtained by pooling a set of diverse attribution models. The weights assigned to the individual models in the pool are based on the log score criterion, an information-theoretic measure of the conditional performance of a model. We illustrate the advantages of a pooled benchmark over alternative approaches, including the Fung and Hsieh [Fung W, Hsieh DA (2004) Hedge fund benchmarks: A risk-based approach. Financial Analysts J. 60:65–80] model, stepwise regression methods, and style-adjusted methods in the contexts of a real-time investment strategy, hedge fund replication, and fund failure prediction. This paper was accepted by Wei Jiang, finance .

Suggested Citation

  • Michael S. O’Doherty & N. E. Savin & Ashish Tiwari, 2016. "Evaluating Hedge Funds with Pooled Benchmarks," Management Science, INFORMS, vol. 62(1), pages 69-89, January.
  • Handle: RePEc:inm:ormnsc:v:62:y:2016:i:1:p:69-89
    DOI: 10.1287/mnsc.2014.2056
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    File URL: http://dx.doi.org/10.1287/mnsc.2014.2056
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    References listed on IDEAS

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    Cited by:

    1. Allen, D.E. & McAleer, M.J. & Singh, A.K., 2016. "A Multi-Criteria Portfolio Analysis of Hedge Fund Strategies," Econometric Institute Research Papers EI2016-46, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
    2. Canepa, Alessandra & de la O. González, María & Skinner, Frank S., 2020. "Hedge fund strategies: A non-parametric analysis," International Review of Financial Analysis, Elsevier, vol. 67(C).
    3. David E. Allen & Michael McAleer & Abhay K. Singh, 2018. "A Multi-Criteria Financial and Energy Portfolio Analysis of Hedge Fund Strategies," Documentos de Trabajo del ICAE 2018-18, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.

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