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The Nature of Alpha

  • Arthur M. Berd
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    We suggest an empirical model of investment strategy returns which elucidates the importance of non-Gaussian features, such as time-varying volatility, asymmetry and fat tails, in explaining the level of expected returns. Estimating the model on the (former) Lehman Brothers Hedge Fund Index data, we demonstrate that the volatility compensation is a significant component of the expected returns for most strategy styles, suggesting that many of these strategies should be thought of as being `short vol'. We present some fundamental and technical reasons why this should indeed be the case, and suggest explanation for exception cases exhibiting `long vol' characteristics. We conclude by drawing some lessons for hedge fund portfolio construction.

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    Paper provided by in its series Papers with number 1112.1114.

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    Date of creation: Dec 2011
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    Handle: RePEc:arx:papers:1112.1114
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    1. Drost, Feike C & Nijman, Theo E, 1993. "Temporal Aggregation of GARCH Processes," Econometrica, Econometric Society, vol. 61(4), pages 909-27, July.
    2. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
    3. Drost, F.C. & Nijman, T.E., 1993. "Temporal aggregation of GARCH processes," Other publications TiSEM 0642fb61-c7f4-4281-b484-4, Tilburg University, School of Economics and Management.
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