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CACEIS "New Frontiers in Risk Assessment and Performance Reporting" Research Chair
Asset Allocation and Alternative Diversification
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Natixis "Investment and Governance Characteristics of Infrastructure Debt Instruments" Research Chair
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CME Group "Exploring the Commodity Futures Risk Premium: Implications for Asset Allocation and Regulation" Strategic Research Project
Asset Allocation and Derivative Instruments
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"Investing in Smart Beta" European Seminar Series: Vienna (28 June, 2013)
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"Investing in Smart Beta" European Seminar Series: London (10 July, 2013)
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ERI Scientific Beta
Bernd Scherer The wealth of most investors contains both financial assets as well as non-financial assets. This paper defines shadow assets as (mostly) non-financial and non-tradable assets that are exogenous to the investor’s asset allocation decision. Examples for shadow assets are human capital, non-financial sovereign assets (e.g. underground oil reserves) the present value of future alumni contributions for university endowments or the non-listed family business for the client of a family office. Allocations to these shadow assets can hardly be changed and yet their existence will change the investor’s perspective on total wealth at risk. A revisited version of this paper was published in the Winter 2012 issue of the Journal of Wealth Management. More...
Attilio Meucci Going beyond the simple bid—ask spread overlay for a particular value at risk, this paper introduces a framework that integrates liquidity risk, funding risk, and market risk. We overlay a whole distribution of liquidity uncertainty on future market risk scenarios and we allow the liquidity uncertainty to vary from one scenario to another, depending on the liquidation or funding policy implemented. The result is one easy-to-interpret, easy-to-implement formula for the total liquidity-plus-market-risk profit and loss distribution. A revisited version of this paper was published in the November/December 2012 issue of the Financial Analysts Journal. More...
Frank J. Fabozzi, Arturo Leccadito, Radu S. Tunaru This paper describes a new technique that can be used in financial mathematics for a wide range of situations where the calculation of complicated integrals is required. The numerical schemes proposed here are deterministic in nature but their proof relies on known results from probability theory regarding the weak convergence of probability measures. We adapt those results to unbounded payoffs under certain mild assumptions that are satisfied in finance. Because our approximation schemes avoid repeated simulations and provide computational savings, they can potentially be used when calculating simultaneously the price of several derivatives contingent on the same underlying. This paper was published in the October 2012 issue of Quantitative Finance. More...
Indexes and Benchmarking
Noël Amenc, Felix Goltz, Ashish Lodh This paper clarifies that methodological choices can be made independently on two steps in the construction of alternative equity index strategies – the constituent selection and the choice of a diversification-based weighting scheme. By flexibly combining the different possible choices for these steps we create a large variety of strategies, and test their performance and risk results.
Our results suggest that diversification approaches may be a superior alternative or at least a very important complement to pure stock selection approaches when it comes to reaching a risk/return objective. Moreover, while it is often argued that the risk and performance of diversification-based weighting schemes is solely driven by factor tilts, we show that it is straightforward to correct such tilts through the selection of stocks with appropriate characteristics, while maintaining the improvement in objective that is due to the respective diversification approach. A revisited version of this paper was published in the Fall 2012 issue of the Journal of Portfolio Management. More...
Phelim Boyle, Lorenzo Garlappi, Raman Uppal, Tan Wang This paper develops a model of portfolio choice that nests the views of Keynes—who advocates concentration in a few familiar assets—and Markowitz—who advocates diversification across assets. It relies on the concepts of ambiguity and ambiguity aversion to formalize the idea of an investor's "familiarity" toward assets. More...
Asset Allocation and Derivative Instruments
Lionel Martellini, Vincent Milhau This paper introduces a continuous-time dynamic asset allocation model for an investor facing liability constraints in the presence of inflation and interest rate risks. When funding ratio constraints are explicitly accounted for, the optimal policies, for which we obtain analytical expressions, are shown to extend standard Option-Based Portfolio Insurance (OBPI) strategies to a relative risk context, with the liability-hedging portfolio replacing the risk-free asset. We also show that the introduction of maximum funding ratio targets would allow pension funds to decrease the cost of downside liability risk protection while giving up part of the upside potential beyond levels where marginal utility of wealth (relative to liabilities) is low or almost zero. A revisited version of this paper was published in the October 2012 issue of the Journal of Pension Economics and Finance. More...
Indexes and Benchmarking
Laurent Deville, Carole Gresse, Béatrice de Séverac This paper investigates how the introduction of an index security directly or indirectly impacts the underlying-index spot-futures pricing. Using intraday data for financial instruments related to the CAC 40 index, it does not find that the spot-futures price efficiency improvement observed after ETF introduction is explained either by the direct effect of ETF shares being used in arbitrage trades or by the indirect effect of ETF trading improving the liquidity of index stocks in the short run. A revisited version of this paper is forthcoming in European Financial Management. More...
Jean-Sébastien Fontaine, René Garcia Asset pricing models of limits to arbitrage emphasize the role of funding conditions faced by financial intermediaries. In the US, the Treasury repo market is the key funding market and, hence, theory predicts that the liquidity premium of Treasury bonds share a funding liquidity component with risk premia in other markets. This paper identifies and measures the value of funding liquidity from the cross-section of bonds by adding a liquidity factor correlated with age to an arbitrage-free term structure model. A revisited version of this paper was published in the April 2012 issue of The Review of Financial Studies. More...
Socially Responsible Investment
Abraham Lioui, Zenu Sharma This paper assesses the impact of environmental corporate social responsibility (ECSR) on Corporate Financial Performance (CFP) measured by ROA and Tobin's Q. We show that the relationship between firms' return on assets (ROA) and ECSR, strengths and concerns, is negative and statistically significant. We also show that firms' Tobin Q and ECSR, strengths and concerns, are negatively correlated in a statistically significant way. However, accounting for the interaction between firms' environmental efforts and R&D yields a different perspective: while the direct impact of ECSR on CFP is still negative, the interaction of ECSR and R&D has a positive and significant impact on it. ECSR strengths and concerns harm CFP since they are perceived as a potential cost. However, this CSR activity fosters R & D efforts of firms which generates additional value (indirect effect). This paper was published in the June 2012 issue of Ecological Economics. More...
Indexes and Benchmarking
Ronald J. Ryan, Frank J. Fabozzi Historically, the practice of trustees of defined benefit programs has been to make the asset allocation decision based on prevailing risk-return relationship for asset classes without regard to the plan’s economic funded ratio, liability structure, and liability economic growth rate. Once the asset allocation decision is made, the market index that best represents that asset class is selected as the performance benchmark. Ignoring the liability structure has been the major reason for the failure of both private and public pension funds to achieve their true objective of funding the liability benefit payment schedule at a stable and low cost to the plan sponsor. For trustees to properly manage pension assets in light of the true objective, they need a liability index customized to the fund’s unique benefit payment schedule. This article explains how this should be accomplished and how Alpha and Beta portfolios should be redefined in order to work in harmony with the plan’s true objective. This paper was published in the November 2011 issue of the Journal of Financial Transformation. More...
Frank J. Fabozzi, Dennis Vink This paper provides empirical evidence about the credit factors that affect the pricing of newly issued residential mortgage-backed securities (RMBS) in the U.K. The findings add an important element to the current debate by regulators throughout the world regarding whether investors rely exclusively on credit ratings in making investment decisions. The results show that credit factors such as subordination level and collateral type that are taken into account by credit rating agencies when assigning a rating still have a significant impact on the new issuance spread even after accounting for the credit rating. The implication is that investors do not rely exclusively on ratings. This paper was published in the Winter 2012 issue of the Journal of Fixed Income. More...
Stoyan V. Stoyanov, Svetlozar T. Rachev, Frank J. Fabozzi This paper considers a new approach towards stochastic dominance rules which allows measuring the degree of domination or violation of a given stochastic order and represents a way of describing stochastic orders in general. Examples are provided for the n-th order stochastic dominance and stochastic orders based on a popular risk measure. It demonstrates how the new approach can be used for construction of portfolios dominating a given benchmark prospect. This paper was published in Volume 15, Issue 2 of the International Journal of Theoretical and Applied Finance. More...
Rosella Giacomettia, Marida Bertocchi, Svetlozar T. Rachev, Frank J. Fabozzi With the decline in the mortality level of populations, national social security systems and insurance companies of most developed countries are reconsidering their mortality tables taking into account the longevity risk. The Lee and Carter model is the first discrete-time stochastic model to consider the increased life expectancy trends in mortality rates and is still broadly used today. This paper proposes an alternative to the Lee–Carter model: an AR(1)–ARCH(1) model. More specifically, it compares the performance of these two models with respect to forecasting age-specific mortality in Italy. It fits the two models, with Gaussian and t-student innovations, for the matrix of Italian death rates from 1960 to 2003. It compares the forecast ability of the two approaches in out-of-sample analysis for the period 2004–2006 and finds that the AR(1)–ARCH(1) model with t-student innovations provides the best fit among the models studied in this paper. This paper was published in the January 2012 issue of Insurance: Mathematics and Economics. More...
Frank J. Fabozzi, Sergio M. Focardi The authors argue that current mainstream economics is not a science in the sense of the physical sciences, and they draw some conclusions from the point of view of asset management. Their key point is that economics as embodied in the general equilibrium theories describes an idealized rational economic world as opposed to one based on empirical data. Although this argument has already been made, it has been virtually ignored by economists. The current crisis, however, requires an economic understanding anchored on a solid empirical basis. This paper was published in the Spring 2012 issue of the Journal of Portfolio Management. More...
Indexes and Benchmarking
Felix Goltz, Renata Guobuzaite, Lionel Martellini This paper introduces a new form of volatility index, the cross-sectional volatility index. Through formal central limit arguments, it shows that the cross-sectional dispersion of stock
returns can be regarded as an efficient estimator for the average idiosyncratic volatility of stocks within the universe under consideration. Among the key advantages of the cross-sectional volatility index measure over currently available measures are its observability at any frequency, its model-free nature, and its availability for every region, sector, and style of the world equity markets, without the need to resort to any auxiliary option market. A revisited version of this paper was published in Bankers, Markets & Investors, March 2012. More...
Frank J. Fabozzi, Yuewu Xu This study considers duration measures of any order with respect to inflation and real rates for both nominal bonds and real bonds (i.e., inflation-indexed bonds, or TIPS). The authors demonstrate that these duration measures, as well as the analysis of fixed-income portfolios, take a particularly simple form when examined from the viewpoint of continuously compounded rates. They show that, although the durations of all orders for nominal bonds with respect to inflation and real rates are exactly equal to the usual durations with respect to the nominal rates, the durations of all orders for TIPS with respect to inflation is exactly zero and the duration of all orders for TIPS with respect to real rates can be calculated in the usual way. Under general (non-infinitesimal) changes in the term structures of inflation and real rates, they derive the formulas for the percentage changes in bond prices using higher-order duration measures. Applications to portfolio management such as hedging (or speculating) on the inflation rate using portfolios of nominal bonds and TIPS are discussed. This paper was published in the Spring 2012 issue of the Journal of Fixed Income. More...
Frank J. Fabozzi, Young Shin Kim, Zuodong Lin, Svetlozar T. Rachev In this paper, we discuss a stochastic volatility model with a Lévy driving process and then apply the model to option pricing and hedging. The stochastic volatility in our model is defined by the continuous Markov chain. The risk-neutral measure is obtained by applying the Esscher transform. The option price using this model is computed by the Fourier transform method. We obtain the closed-form solution for the hedge ratio by applying locally risk-minimizing hedging. This paper was published in Volume 15, Issue 1 of the Review of Derivatives Research. More...
Frank Fabozzi, Young Shin Kim, Svetlozar Rachev, Matthias Scherer There is considerable empirical evidence that financial returns exhibit leptokurtosis and nonzero skewness. As a result, alternative distributions for modelling a time series of the financial returns have been proposed. A family of distributions that has shown considerable promise for modelling financial returns is the tempered stable and tempered infinitely divisible distributions. Two representative distributions are the classical tempered stable and the Rapidly Decreasing Tempered Stable (RDTS). In this article, we explain the practical implementation of these two distributions by (1) presenting how the density functions can be computed efficiently by applying the Fast Fourier Transform (FFT) and (2) how standardization helps to drive efficiency and effectiveness of maximum likelihood inference. This paper was published in Volume 22, Issue 16 of Applied Financial Economics. More...
Frank J. Fabozzi, Radu Tunaru, Robert Shiller New methods are developed here for pricing the main real estate derivatives - futures and forward contracts, total return swaps, and options. Accounting for the incompleteness of this market, a suitable modelling framework is outlined that can produce exact formulae, assuming that the market price of risk is known. This framework can accommodate econometric properties of real-estate indices such as predictability due to autocorrelations. The term structure of the market price of risk is calibrated from futures market prices on the Investment Property Databank index. The evolution of the market price of risk associated with all five futures curves during 2009 is discussed. This paper was published in the November 2012 issue of European Financial Management. More...
Frank Fabozzi, Dennis Vink In this paper, we empirically investigate what credit factors investors rely upon when pricing the spread at issue for European asset-backed securities. More specifically, we investigate how credit factors affect new issuance spreads after taking into account credit rating. We do so by investigating primary market spreads for tranches of non-mortgage-related asset-backed securities issued from 1999 to the year prior to the subprime mortgage crisis, 2007. We find that although credit ratings play a major role in determining spreads, investors appear to not rely exclusively on these ratings. Our findings strongly suggest that investors do not ignore other credit factors beyond the assigned credit rating. This paper was published in the September 2012 issue of European Financial Management. More...
Noël Amenc, François Cocquemas, Samuel Sender This survey analyses the views of European fund industry professionals on non-financial risk and performance in a changing regulatory framework. It analyses the risks those in the industry face as a result of regulation and of their practices, assesses their importance and impact in terms of solvency and business models, and proposes methods to attenuate them. The survey is based on replies from 163 high-level professionals of diverse horizons from the European fund management industry. The results show that at the top of the list of concerns are transparency, information and governance, followed by the financial responsibility of the fund management industry. The survey also covers themes such as restitution and depositary liabilities, distribution and judicial powers of investors. A revisited version of this paper was published in the March 2012 issue of Bankers, Markets & Investors. More...
Bernd Scherer This paper shows that revenues from a sample of publicly traded US asset management companies carry substantial market risks. Not only does this challenge the academic risk management literature about the predominance of operative risks in asset management. It also is at odds with current practice in asset management firms. Asset managers do not hedge market risks even though these risks are systematically built into the revenue generation process. A revisited version of this paper was published in Quantitative Finance, Volume 12, Issue 10, 2012. More...
Mathieu Vaissié There is growing empirical evidence that the complexity of financial markets makes it increasingly challenging for institutional investors to manage their asset/liability profile efficiently. Changes in the regulatory framework and in accounting rules make it even trickier for insurance companies. Against this backdrop, insurers have no choice but to rethink their overall investment policy. A revisited version of this paper was published in the Fall 2012 issue of the Journal of Alternative Investments. More...
Stoyan V. Stoyanov, Svetlozar T. Rachev, Frank J. Fabozzi Risk management through marginal rebalancing is important for institutional investors due to the size of their portfolios. This paper considers the problem of marginally improving portfolio VaR and CVaR through a marginal change in the portfolio return characteristics. It studies the relative significance of standard deviation, mean, tail thickness, and skewness in a parametric setting
assuming a Student's t or a stable distribution for portfolio returns. A revisited version of this paper was published in the May 2013 issue of Annals of Operations Research. More...
Credit Default Swaps
Dominic O’Kane This paper performs a theoretical and empirical analysis of the relationship between the price of Eurozone sovereign-linked credit default swaps (CDS) and the same sovereign bond markets during the Eurozone debt crisis of 2009-2011. It first presents a simple model which establishes the no-arbitrage relationship between CDS and bond yield spreads. A revisited version of this paper was published in the March 2012 issue of Bankers, Markets & Investors. More...
Jim Clayton, Frank J. Fabozzi, S. Michael Giliberto, Jacques N. Gordon, Susan Hudson-Wilson, William Hughes, Youguo Liang, Greg MacKinnon, Asieh Mansour The real estate investment management industry has been undergoing a process of change over the last two decades. The market is far more transparent than it once was due to the availability of far more, and more detailed, market information. Combined with the increasing integration of real estate with the broader capital markets, this has led to a market that reacts more quickly to events, exhibits more volatility, and in which the nature of risk has changed. These ongoing changes in the market, combined with the lessons of the financial crisis, have resulted in risk management becoming a topic of primary importance in real estate investment. This paper was published in the Special Real Estate Issue 2011 of The Journal of Portfolio Management. More...
Indexes & Benchmarking
Noël Amenc, Felix Goltz, Lin Tang As the choice of an index is a crucial step in both asset allocation and performance measurements, it is useful to investigate index use and perceptions about indices. The EDHEC-Risk European Index Survey 2011 analyses the current uses of and opinions on stock, bond and equity volatility indices with the aim of providing unique insight into the users’ perspective in the index industry. An article based on this survey was published in the Summer 2012 issue of the Journal of Index Investing. More...
Yosef Bonaparte, Frank J. Fabozzi Since the work by Stigler (1961) on the economics of information in the early 1960s, economists have paid closer attention to the role of search for information. However, search methods are not considered in the theory of portfolio choice. We present a model of investor search behaviour in order to provide a framework by which to evaluate our empirical evidence on the role of search in portfolio selection and performance. We study two types of search methods: informal and professional. We show that the income, wealth and risk preference of households influence their search choice. This paper was published in the October 2011 issue of Applied Economics. More...
Victor DeMiguel, Yuliya Plyakha, Raman Uppal, Grigory Vilkov The objective of this paper is to examine whether one can use option-implied information to improve the selection of portfolios with a large number of stocks, and to document which aspects of option-implied information are most useful for improving their out-of-sample performance. Portfolio performance is measured in terms of four metrics: volatility, Sharpe ratio, certainty-equivalent return and turnover. A revisited version of this paper is forthcoming in the Journal of Financial and Quantitative Analysis. More...
Dominic O’Kane Issues of contemporaneity, liquidity, different restructuring clauses and market supply and demand, all contribute to the fact that the market quoted term structure of CDS index spreads does not always agree with the term structure of CDS index spreads implied by the CDS term structures of the constituent credits. A revisited version of this paper was published in the Spring 2011 issue of the Journal of Derivatives. More...
Barry Schachter, S. Ramu Thiagarajan Mean-Variance optimisation has come under great criticism recently, based on the poor performance experienced by asset managers during the global financial crisis. In response, an alternative approach, called Risk Parity, which proceeds by equalising risk contributions, has garnered much interest. This paper summarises the work of a group of leading researchers on Risk Parity. A revisited version of this paper was published in the Spring 2011 issue of the Journal of Investing. More...
Bernd Scherer Disappointed with the performance of market-weighted benchmark portfolios yet skeptical about the merits of active portfolio management, investors in recent years turned to alternative index definitions. Minimum variance investing is one of these popular rule driven, i.e. new passive concepts. This paper shows theoretically and empirically that the portfolio construction process behind minimum variance investing implicitly picks up risk-based pricing anomalies. In other words the minimum variance tends to hold low beta and low residual risk stocks. Long/short portfolios based on these characteristics have been associated in the empirical literature with risk-adjusted outperformance (alpha). This paper shows that 83% of the variation of the minimum variance portfolio excess returns (relative to a capitalization-weighted alternative) can be attributed to the FAMA/FRENCH factors as well as to the returns on two characteristic anomaly portfolios. All regression coefficients (factor exposures) are highly significant, stable over the estimation period and correspond remarkably well with our economic intuition. A revisited version of this paper was published in the September 2011 issue of the Journal of Empirical Finance. More...
Stephen J. Brown, Greg N. Gregoriou, Razvan Pascalau Samuelson (1967) argues that as a general matter it is easy to show that investors should be maximally diversified. For this reason many institutions are attracted to diversified portfolios of hedge funds, referred to as Funds of Hedge Funds (FOFs). In this paper we examine a new database that separates out for the first time the effects of diversification (the number of underlying hedge funds) from scale (the magnitude of assets under management). We find with others that the variance reducing effects of diversification peter out once FOFs hold more than 20 underlying hedge funds. Yet the majority of FOFs are more diversified than this. We find a new and surprising result that this excess diversification actually increases the left tail risk exposure of FOFs particularly once we account for the extent to which hedge fund returns are smoothed. A revisited version of this paper was published in the June 2012 issue of the Review of Asset Pricing Studies. More...
Daniel Giamouridis, Chris Montagu Valuation signals have been among the most popular with equity portfolio managers and have recently attracted significant interest from cross-asset managers. Given a large variation of techniques and theories with regard to how value is measured, this paper investigates the efficacy of alternative value measures. It considers a cross-section of simple and sophisticated alternative measures and focuses on comparison metrics that are of primary interest for equity portfolio managers. A revisited version of this paper is forthcoming in European Financial Management. More...
Ekkehart Boehmer, Julie Wu This paper shows that stock prices impound more information when short sellers are more active. First, in a large panel of NYSE-listed stocks, high-frequency informational efficiency of prices improves with greater daily shorting flow. Second, at monthly and annual horizons, more shorting flow accelerates the incorporation of public information into prices. Third, greater shorting flow reduces post-earnings announcement drift for negative earnings surprises. Fourth, we demonstrate that short sellers change their trading around extreme return events in a way that aids price discovery. These results are robust to various econometric methodologies and model specifications. Overall, the results highlight the important role that short sellers play in the price discovery process. A revisited version of this paper is forthcoming in European Financial Management. More...
Greg N. Gregoriou, François-Serge Lhabitant, Fabrice Douglas Rouah This paper attempts to determine whether exchange-listed hedge funds experience longer lifetimes than non-listed funds, even after factors known to affect survival, such as size and performance, are considered. The Kaplan-Meier estimator is used to compare survival times of listed and non-listed funds. The Cox proportional hazards model is used to make the same comparison, but by controlling for additional factors. The accelerated failure time (AFT) regression model is used to estimate the median survival time of hedge funds, based on values of explanatory variables. A revisited version of this paper was published in the December 2009 issue of the Journal of Applied Research in Accounting and Finance. More...
James Chong, Joëlle Miffre, Simon Stevenson This paper studies the temporal variations in the conditional correlations between REIT returns and equity, bond and commodity returns. While REITs are often presented as useful tools for diversification, little is known of the way their returns correlate with the returns of other asset classes over time and in periods of high volatility. This paper addresses this issue and draws two conclusions. First, the correlations between REITs and equity returns rose over the period analyzed, while the correlations with bonds and commodities fell. This indicates to equity portfolio managers that real estate has lost some of its diversification properties, but to bond and commodity portfolio managers it has become attractive for strategic asset allocation. Second, the correlations with REITs rose especially in periods of above average volatility in equity and bond markets. This is unfortunate as it is precisely in periods of high volatility that investors need the benefits of diversification the most. A revisited version of this paper was published in the April 2009 issue of the Journal of Real Estate Portfolio Management.
Rodrigo Dupleich, Daniel Giamouridis, Chris Montagu This paper investigates the potential improvement in the implementation of style rotation strategies by techniques addressing estimation errors. We select two approaches that have recently stood out in the statistics and econometric literature and have been applied to portfolio construction literature. One builds on regularization methods which address estimation error by focusing on the weights of the constructed portfolios. And a second method that uses pooled forecasts obtained across different observation windows. Thus it focuses on minimizing estimation error in the moments of the return distribution that may arise due to structural breaks. We conclude that overall there are benefits from departing from naïve approaches which can be as significant as an improvement in the information ratio of about 54%, i.e., from 0.65 (naïve) to about 1 (dynamic). A revisited version of this paper was published in the Winter 2012 issue of the Journal of Portfolio Management. More...
Paul Klumpes This paper explores the financial statement implications of alternative measurement bases underlying defined benefit pension accounting rules via a simulation analysis. Simulation analysis can be used to examine the effect of alternative discount rate assumptions on the strength of associations between an economic or generational accounting basis, an actuarial funding basis of measurement and two alternative accounting measurement bases of pension assets and liabilities; value-in-use and value-in-exchange. Accounting measures are found to be more highly correlated with economic unfunded pension liabilities when they are discounted using market instead of value in use rates. The value at use rates are also more highly sensitive to differences in funding method, real versus nominal interest rates and plan initiation dates. The findings suggest that the use of alternative measurement bases for pension reporting and funding involves a trade-off between the relevance and reliability of the resulting pension disclosures. A revisited version of this paper was published in "Insurance Markets and Companies: Analyses and Actuarial Computations", Issue 1, 2010. More...
Frank J. Fabozzi, Sergio Focardi, Masao Fukushima, Dashan Huang, Zudi Lu, Baimin Yu Instead of assuming the distribution of return series, Engle and Manganelli (2004) propose a new Value-at-Risk (VaR) modeling approach, Conditional Autoregressive Value-at-Risk (CAViaR), to directly compute the quantile of an individual asset’s returns which performs better in many cases than those that invert a return distribution. This paper explores more flexible CAViaR models that allow VaR prediction to depend upon a richer information set involving returns on an index. Specifically, we formulate a time-varying CAViaR model whose parameters vary according to the evolution of the index. A revisited version of this paper was published in the March 2010 issue of Studies in Nonlinear Dynamics & Econometrics. More...
Asmerilda Hitaj, Lionel Martellini, Giovanni Zambruno Since hedge fund returns are not normally distributed, mean-variance optimisation techniques, which would lead to substantial welfare losses from the investor’s perspective, need to be replaced by optimisation procedures incorporating higher-order moments and comoments. In this context, optimal portfolio decisions involving hedge fund style allocation require not only estimates for covariance parameters but also estimates for coskewness and cokurtosis parameters. This is a formidable challenge that severely exacerbates the dimensionality problem already present with mean-variance analysis. This paper presents an application of the improved estimators for higher-order co-moment parameters, recently introduced by Martellini and Ziemann (2010), in the context of hedge fund portfolio optimisation. A revisited version of this paper was published in the Winter 2012 issue of the Journal of Alternative Investments. More...
Serge Darolles, Mathieu Vaissié In spite of a somewhat disappointing performance throughout the crisis, and a series of high-profile scandals, investors are showing interest in hedge funds. Still, funds of hedge funds keep on experiencing outflows. Can this phenomenon be explained by the failure of fund of hedge fund managers to deliver on their promise to add value through active management, or is it symptomatic of a move toward greater disintermediation in the hedge fund industry? Little attention has been paid so far to the added value, and the sources of the added value, of funds of hedge funds. A revisited version of this paper was published in the April 2012 issue of the Journal of Banking and Finance. More...
Lionel Martellini, Vincent Milhau In an attempt to address the concern over financially illiterate individuals being increasingly responsible for investment decisions related to retirement risk, the financial industry has started to design dedicated mutual fund products known as target date funds. These funds, whose aim is to provide investors with one-stop solutions to their life-cycle investment needs, typically propose a deterministic decrease of equity allocation until a date called the target date of the fund. This approach, however, has been found inconsistent with the prescriptions of standard life-cycle investment models (Viceira and Field 2007). A revisited version of this paper was published in the November-December 2010 issue of Bankers, Markets & Investors.
Indexes and Benchmarking
Noël Amenc, Felix Goltz, Lionel Martellini, Shuyang Ye This paper analyses a set of equity indices whose aim is to improve on capitalisation weighting and thus to provide “improved beta”. Four main weighting schemes are analysed: efficient indices, fundamental indices, minimum-volatility indices, and equal-weighted indices. Empirical results for US and Developed World data on these indices show that the average returns of all four alternative index construction methods are superior to those of cap-weighted equity indices in both universes and that, by several measures of risk-adjusted performance, they are likewise superior. A revisited version of this paper was published in the January/February 2011 issue of the Journal of Indexes. More...
Greg N. Gregoriou, Razvan Pascalau Can investors select winning funds of hedge funds (FOFs) by merely assuming a simple trading strategy? Can historical information present insight on future returns? Financial theory presumes that stock markets are efficient and using any type of trading strategy will not be successful in the long-run. This article investigates a pure simple trading strategy to see if selecting last year’s top-performing FOFs as this year’s choice can outperform three FOF indexes and the S&P 500 Index. It further applies the strategy to the top-performing onshore and offshore funds, respectively, and compares them to the HFR Onshore and HFR Offshore indices, respectively. This paper was published in the Fall 2010 issue of the Journal of Wealth Management. More...
Indices and Benchmarking
Felix Goltz, Véronique Le Sourd Proponents of cap-weighted stock market indices often argue that such indices provide efficient risk/return portfolios. This paper reviews the evidence in the academic literature and concludes that only under very unrealistic assumptions would such indices be efficient investments. In the presence of realistic constraints and frictions, cap-weighted indices cannot, according to the academic literature, be expected to be efficient investments. A revisited version of this working paper was published in the Fall 2011 issue of the Journal of Index Investing. More...
Abraham Lioui The ban on shorting had negative effects on the hedge fund industry. It also had a negative impact on the returns and the market quality of the stocks placed off limits by the ban. This paper examines the impact of the ban on broad market indices in the US and in Europe (the United Kingdom, France, and Germany). Since these indices and their performance are of great concern to the asset management and hedge fund industries, it is important for practitioners and policy-makers to understand the impact of changing the rules of the game (banning short sales) on the return distribution of these indices and to assess the potential spillover effects of a counter-cyclical regulation affecting only one segment of the financial market. The paper shows that the ban had a broad impact on the markets. A revisited version of this paper was published in the Winter 2011 issue of the Journal of Alternative Investments. More...
Noël Amenc, Samuel Sender As part of the CACEIS research chair on non-financial risks in investment funds, EDHEC surveyed UCITS and alternative asset managers, their service providers, external observers, and investors for their views of structuring hedge fund strategies as UCITS. The 437 respondents report assets under management (AUM) of more than €13 trillion. Investment fund managers account for roughly €7 trillion of these assets. In general, the survey suggests that institutional investors bound by quantitative restrictions will ask fund managers and distributors to repackage hedge fund strategies as UCITS. For their part, managers of alternative funds are concerned by the uncertainties surrounding the directive on alternative investment fund managers (AIFMs) and may consider packaging their strategies as UCITS. Most respondents, however, fear that structuring hedge fund strategies as UCITS will distort strategies and diminish returns. A paper based on this study was published in the Journal of Alternative Investments, Fall 2012. More...
Fousseni Chabi-Yo, René Garcia, Eric Renault Risk aversion functions extracted from observed stock and option prices can be negative as shown by Aït-Sahalia and Lo (2000) and Jackwerth (2000). We rationalize this puzzle by a lack of conditioning on latent state variables. Once properly conditioned, risk aversion functions and pricing kernels are consistent with economic theory. A revisited version of this working paper was published in the April 2008 issue of the Review of Financial Studies. More...
Indexes and Benchmarking
Noël Amenc, Felix Goltz, Lionel Martellini, Patrice Retkowsky This paper introduces a novel method for the construction of equity indices that, unlike their cap-weighted counterparts, offer an efficient risk/return tradeoff. The index construction method goes back to the roots of modern portfolio theory and focuses on the tangency portfolio, the portfolio that weights index constituents so as to obtain the highest possible Sharpe ratio. The major challenge is to generate the required input parameters in a robust manner. A revisited version of this working paper was published in the Fourth Quarter 2011 issue of the Journal of Investment Management. More...
Lionel Martellini, Volker Ziemann In the presence of non-normally distributed asset returns, optimal portfolio selection techniques require estimates for variance-covariance parameters, along with estimates for higher-order moments and comoments of the return distribution. This is a formidable challenge that severely exacerbates the dimensionality problem already present with mean-variance analysis. This paper extends the existing literature, which has mostly focused on the covariance matrix, by introducing improved estimators for the coskewness and cokurtosis parameters. A revisited version of this paper was published in the April 2010 issue of the Review of Financial Studies. More...
François-Serge Lhabitant Following the 2008 financial crisis, private financial institutions such as hedge funds and private equity funds have been faced with multiple calls for their regulation, both for consumer protection and systemic reasons. Various proposals for a new regulation have been made and are currently under discussion. The hedge fund community is also open to reasonable regulations. In this paper, we discuss some of the key aspects of the SEC and the European Union proposals and argue that both of them suffer from severe shortcomings. A revisited version of this paper was published in the Journal of Financial Transformation, volume 27 (2009). More...
Felix Goltz, Wan Ni Lai Recent studies find that a position in at-the-money (ATM) straddles consistently yields losses. This is interpreted as evidence for the non-redundancy of options and as a risk premium for volatility risk. This paper analyses this risk premium in more detail by i) assessing the statistical properties of ATM straddle returns, ii) linking these returns to exogenous factors and iii) analysing the role of straddles in a portfolio context. A revisited version of this paper was published in the Fall 2009 issue of the Journal of Derivatives. More...
Noël Amenc, Felix Goltz, Adina Grigoriu This paper examines the ways dynamic asset allocation techniques can be used to manage portfolios of exchange-traded funds (ETFs). First, dynamic allocation to stock and bond ETFs and traditional static diversification are compared. Second, tactical allocation to stock and bond ETFs and risk-controlled allocation—with both forms of allocation informed by the same return forecasts—are compared. The paper shows that dynamic asset allocation techniques that can be used with frequently traded and broadly diversified instruments such as ETFs make it possible better to address investor concerns over drawdown and intra-horizon risk, whether or not the manager wishes to make return predictions. A revisited version of this working paper was published in the Fall 2010 issue of the Journal of Alternative Investments. More...
Bernhard Scherer Hull (2007) writes: “For an asset manager the greatest risk is operational risk”. In 2008, however, asset management companies came under severe pressure not from operational risk, but from market risk. What had been seen as an annuity stream that was thought to expose firms to little or no earnings risk turned out to be directional stock market exposure combined with high operational leverage. A revisited version of this working paper was published in the Fall 2010 issue of the Journal of Applied Corporate Finance. More...
Transaction Cost Analysis
Stephen Satchell, Bernhard Scherer We show that non-linear transaction costs generate external effects between accounts due to trade volume dependent marginal transaction costs. For an asset manager with multiple clients this raises the question of fairness. How do I ensure I treat all clients fairly? In general, two possible solutions exist. A revisited version of this paper was published in the Winter 2010 issue of the Journal of Trading. More...
Christophette Blanchet-Scalliet, Nicole El Karoui, Monique Jeanblanc, Lionel Martellini Many investors do not know with certainty when their portfolio will be liquidated. Should their portfolio selection be influenced by the uncertainty of exit time? In order to answer this question, we consider a suitable extension of the familiar optimal investment problem of Merton (1971), where we allow the conditional distribution function of an agent’s time horizon to be stochastic and correlated to returns on risky securities. In contrast to existing literature, which has focused on an independent time horizon, we show that the portfolio decision is affected. A revisited version of this paper was published in the December 2008 issue of the Journal of Mathematical Economics. More...
Sovereign Wealth Funds
Bernhard Scherer The vast current account surpluses of commodity-rich nations, combined with record current account deficits in developed markets (US, Britain), have created a new type of investor. Sovereign wealth funds (SWFs) are instrumental in deciding how these surpluses will be invested. A revisited version of this paper was published in Financial Markets and Portfolio Management, Vol. 23, 2009, Nº 3. More...
Sovereign Wealth Funds
Bernhard Scherer Given recent interest in the activities of sovereign wealth funds (SWFs), this paper reviews the financial economics of portfolio choice for oil-based investors. It views the optimal asset allocation problem of a sovereign wealth fund as the decision-making problem of an investor with non-tradable endowed wealth (oil reserves). Optimal portfolios combine speculative demand (optimal growth) as well as hedging demand (hedging resource fluctuation risk) and the level of risk taking should depend both on the fraction of financial wealth to resource wealth and on the oil shock hedging properties of the investments. A revisited version of this working paper was published in the Winter 2011 issue of the Journal of Alternative Investments. More...
Sovereign Wealth Funds
Bernhard Scherer The existence of oil stabilization funds as the largest category of sovereign wealth funds relies on oil prices as a main source of macroeconomic risk for oil exporting countries. Given the often contingent spending policies of oil stabilization funds (accumulating wealth when oil prices are rising and spending wealth to support the local economy when GDP is shrinking) it is important to understand the magnitude and relative importance of oil price shocks relative to other sources of macroeconomic risk. A revisited version of this working paper was published in issue nº 109 (December 2010) of Bankers, Markets & Investors. More...
Georges Hübner The relevance of the information ratio and the alpha, two leading performance measures for multi-index models, depends on the type of portfolio held by investors. This paper compares these measures with the generalized treynor ratio (GTR) on the quality of the rankings they produce. A precise measure yields similar rankings with alternative benchmarks. A revisited version of this paper was published in the Summer 2007 issue of the Journal of Portfolio Management. More...
Abraham Lioui, Patrice Poncet This paper solves for the equilibrium of a standard real business cycle model with money under model ambiguity. It first shows that monetary certainty is a sufficient condition for an interest rate smoothing rule to be optimal even under preferences for model robustness on the part of private agents. It then derives the necessary and sufficient condition for a stochastic (but stationary) monetary policy to reproduce the equilibrium of the real economy and compute the optimal (constant) level of the nominal interest rate. A revisited version of this paper was published in the December 2012 issue of the Journal of Macroeconomics. More...
Private Wealth Management
Noël Amenc, Lionel Martellini, Vincent Milhau, Volker Ziemann While the private banking industry is in general relatively well equipped on the tax planning side, with tools that can allow private bankers to analyse the situation of high net worth individuals operating offshore or in multiple tax jurisdictions, the software packages used on the financial simulation side often suffer from significant limitations and cannot satisfy the needs of a sophisticated clientele. In fact, most financial software packages used by private bankers to generate asset allocation recommendations rely on single-period mean-variance asset portfolio optimisation, a tactic that, for at least two reasons, cannot lead to proper strategic allocation. This study provides a formal framework suggesting that asset-liability management can ensure that private wealth managers are able to offer their clients investment programmes and asset allocation advice that truly meet their needs. A revisited version of this paper was published in the Fall 2009 issue of the Journal of Portfolio Management. More...
Alberto Chonga, Jorge Guillenb, Florencio Lopez-de-Silanes Based on a newly assembled firm-level data set on corporate governance and firm performance for Mexico, we show that better firm-level corporate governance practices are linked to higher valuations, better performance and more dividends disbursed to investors. These results hold after controlling for endogeneity. Overall, the evidence shows that the Mexican legal environment poses serious problems for access to capital. This paper was published in the September 2009 issue of the Journal of Economic Policy Reform. More...
Noël Amenc, Lionel Martellini, Jean-Christophe Meyfredi, Volker Ziemann In this paper we extend Hasanhodzic and Lo (2007) by assessing the out-of-sample performance of various non-linear and conditional hedge fund replication models. We find that going beyond the linear case does not necessarily enhance the replication power. On the other hand, we find that
selecting factors on the basis of an economic analysis can lead to a substantial improvement in out-of-sample replication quality, whatever the underlying form of the factor model. A revisited version of this paper was published in the March 2010 issue of European Financial Management. More...
Rodrigo Dupleich, Daniel Giamouridis, Spyros Mesomeris, Nima Noorizadeh This article is concerned with the systematic exposures of equity hedge fund managers. In particular, we seek common systematic exposures of equity hedge funds through rigorous model selection techniques. We study their time variance to determine whether the style characteristics of equity hedge funds are stable over time. Most importantly, we explore the informational role of manager decisions in shifting their exposures to certain styles. Our results suggest that equity fund managers are exposed to three dominant style strategies, namely, ‘market’, ‘value’ and ‘momentum’. We also discover that there is a considerable degree of variability in the factor exposures over time for the various dominant sources of systematic risk/return. Finally, we provide evidence that managers vary their exposures to the ‘market’ in time to exploit favourable market moves. However, a similar pattern is not observed for their ‘value’ or ‘momentum’ exposures. This paper was published in the April 2010 issue of the Journal of Asset Management. More...
Noël Amenc, Lionel Martellini, Volker Ziemann This paper presents an empirical analysis
of the benefits of alternative forms of
investment strategies from an asset-liability
management perspective. Using a vector error correction model (VECM)
that explicitly distinguishes between short-term
and long-term dynamics in the joint
distribution of asset returns and inflation,
we identify the presence of long-term
cointegration relationships between the
return on typical pension fund liabilities
and the return of various traditional and
alternative asset classes. A revisited version of this paper was published in the Summer 2009 issue of The Journal of Portfolio Management. More...
Greg N. Gregoriou, François-Serge Lhabitant For more than seventeen years, Bernard Madoff operated what was viewed as one of the most successful investment strategies in the world. This strategy ultimately collapsed in December 2008 in what financial experts are calling one of the most detrimental Ponzi schemes in history. Many large and otherwise sophisticated bankers, hedge funds, and funds of funds have been hit by his alleged fraud. In this paper, we review some of the red flags that any operational due diligence and quantitative analysis should have identified as a concern before investing. We highlight some of the salient operational
features common to best-of-breed hedge funds, features that were clearly missing from Madoff’s operations. A revisited version of this paper was published in the Summer 2009 issue of The Journal of Wealth Management. More...
Felix Goltz, David Schröder Like any investors, investors in hedge funds are naturally interested in knowing how hedge fund managers allocate their initial investment, and whether this allocation yields positive returns or not. It is not only information on past investment returns that is of particular interest; prospects for future gains or losses are relevant to investors as well. Yet, unlike mutual funds, hedge funds are reluctant to provide detailed information on their investment portfolios. Since many hedge funds use highly speculative investment strategies, fund managers fear that a thorough disclosure of their portfolio holdings would significantly decrease their chances of winning their bets, and thereby reduce investors' returns. But incomplete disclosure can have some undesirable side effects. A revisited version of this research was published in the Spring 2010 issue of the Journal of Alternative Investments.
Private Wealth Management
With the great economic growth of the past decade, private wealth management
has become a very profitable business for banks worldwide. As a result, more
and more asset management firms have jumped into the fray and competition has increased steadily. These industry changes have led to renewed attempts to improve client relationships and to develop tools and methods to enhance advisor effectiveness. Catering to the client’s specific needs is thus a central concern of private wealth managers. To take the client objectives into account, investments are frequently adapted to the client’s risk aversion, tax situation, and investment horizon. A revisited version of this paper was published in the Winter 2009 issue of the Journal of Wealth Management. More...
Catherine D'Hondt, Jean-René Giraud In this paper, EDHEC emphasises an important issue that is probably not the expected outcome of MiFID. Even though we recognise that the intentions of the Directive are clearly both to ensure market integrity and protect end investors, we have serious concerns about the results one can expect from the newly introduced requirements related to pre-trade transparency. This paper was published in the Spring 2008 issue of the Journal of Trading. More...
This paper analyses a set of characteristics-based indices that have recently been launched on the US market and have been said to outperform standard market cap-weighted indices over particular backtest samples.
The EDHEC authors, Noël Amenc, Felix Goltz and Véronique Le Sourd, analyse the performance of an exhaustive list of such indices and show that the outperformance over value-weighted indices may be negative over long time periods and that characteristics-based indices do not significantly outperform simple equal-weighted indices.
Furthermore, an analysis of both the style exposures and the sector exposures of characteristics-based indices reveals a significant value tilt. When properly adjusting for this tilt, these indices do not show any abnormal performance. A revisited version of this paper was published in the March 2009 issue of European Financial Management. More...
The EDHEC European ETF Survey 2008 is part of the EDHEC Risk and Asset
Management Research Centre’s Indices and Benchmarking research programme. This programme has led to extensive research on indices and benchmarks in both the hedge fund universe and the more traditional investment classes. In 2006, EDHEC published a study of the quality
of major stock market indices. Following up on this study, EDHEC is carrying out
work that assesses the advantages and disadvantages of various new forms of
In view of the growth and development of ETFs in Europe, and in view of their
growing popularity as investment media for both index management and
the construction of benchmarks, it is only natural that EDHEC should devote
significant resources to research into ETFs. In 2006, with the support of iShares, we published the first EDHEC European ETF survey. The present survey, an update and extension of the 2006 survey, sheds light on recent developments and trends in ETF investing.
An article based on this survey was published in the Summer 2009 issue of the Journal of Alternative Investments. More...
As part of its ongoing policy of monitoring asset management practices and comparing them with the results of academic research, the EDHEC Risk and Asset Management Research Centre undertook an in-depth survey of the risk management, portfolio construction, strategic allocation, and performance measurement practices of European asset managers and investors.
The EDHEC European Investment Practices Survey is built on a sample of 229 institutional investors and asset managers who, with respect both to the nationality of survey respondents and to the amount of assets under management, are largely representative of the European asset management industry. In all, respondents to the survey have more than €10 trillion of assets under management and include the major European firms in the industry (nearly fifty respondents manage more than €100 billion each).
An article based on some of the findings of this survey was published in the May/June 2011 issue of the Financial Analysts Journal. More...
Ana-Maria Fuertes, Joëlle Miffre, Georgios Rallis This paper examines the combined role of momentum and term structure signals for the design of profitable trading strategies in commodity futures markets. With significant annualized alphas of 10.14% and 12.66% respectively, the momentum and term structure strategies appear profitable when implemented individually. A revisited version of this working paper was published in the October 2010 issue of the Journal of Banking and Finance. More...
James Chong, Joëlle Miffre The article studies the temporal variations in the conditional return correlations between commodity futures and traditional asset classes (global stock and fixed-income indices). It reveals that the conditional correlations between commodity futures and S&P500 returns fell over time, a sign that commodity futures have become better tools for strategic asset allocation. The correlations with equity returns also fell in periods of above average volatility in equity markets. We see this as welcome news to long institutional investors as they need the benefits of diversification most in periods of high volatility in equity markets. Similarly, falls in return correlations between commodity futures and Treasury-bills go hand in hand with rises in short-term interest volatility, suggesting that adding commodity futures to Treasury-bill portfolios reduces risk further in volatile interest rate environments. A revisited version of this working paper was published in the Winter 2010 issue of the Journal of Alternative Investments. More...
René Garcia, Georges Tsafack Equity returns are more dependent in bear markets than in bull markets. Previous studies have argued that a multivariate GARCH model or a regime switching (RS) model based on normal innovations could reproduce this asymmetric extreme dependence. This paper shows analytically that it cannot be the case. It proposes an alternative model that allows for tail dependence in lower returns and keeps tail independence for upper returns. This model is applied to international equity and bond markets to investigate their dependence structure. A revisited version of this paper was published in the August 2011 issue of the Journal of Banking and Finance. More...
Antonio Diez de los Rios, René Garcia Several studies have put forward that hedge fund returns exhibit a non-linear relationship with equity market returns, captured either through constructed portfolios of traded options or piece-wise linear regressions. This paper provides a statistical methodology to unveil such non-linear features with the returns on any selected benchmark index. It estimate a portfolio of options that best approximates the returns of a given hedge fund, accounts for this search in the statistical testing of the contingent claim features, and tests whether the identifed non-linear features have a positive value. A revisited version of this paper was published in the March 2011 issue of the Journal of Applied Econometrics. More...
Felix Goltz, Lionel Martellini, Koray D. Simsek This paper attempts to determine what fraction a static investor should optimally allocate to investment strategies with convex exposure to stock market returns in a general economy with stochastically time-varying interest rates and stock market excess returns. The results obtained using Monte Carlo analysis show that investors should allocate between 45% and 63% of their
portfolio to such portfolio insurance strategies. Moreover, the inclusion of portfolio insurance strategies leads to important utility gains. The results are robust with respect to the choice of the objective, the presence of realistic levels of market friction, heterogeneous expectations on volatility, and various parametric assumptions. A revisited version of this paper was published in the Journal of Investment Management, Vol. 6 Nº. 2, Second Quarter 2008. More...
Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer This paper presents a new measure of legal protection of minority shareholders against expropriation by corporate insiders: the anti-self-dealing index. Assembled with the help of Lex Mundi law firms, the index is calculated for 72 countries based on legal rules prevailing in 2003, and focuses on private enforcement mechanisms, such as disclosure, approval, and litigation, governing a specific self-dealing transaction. This theoretically-grounded index predicts a variety of stock market outcomes, and generally works better than the previously introduced index of anti-director rights. A revisited version of this paper was published in the June 2008 issue of the Journal of Financial Economics. More...
Finance and Economics
Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer In the last decade, economists have produced a considerable body of research suggesting that the historical origin of a country's laws is highly correlated with a broad range of its legal rules and regulations, as well as with economic outcomes. This paper summarizes this evidence and attempts a unified interpretation. It also addresses several objections to the empirical claim that legal origins matter. Finally, it assesses the implications of this research for economic reform. A revisited version of this paper was published in the June 2008 issue of the Journal of Economic Literature. More...
Aron Balas, Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer Djankov et al. (2003a) propose and measure for 109 countries in the year 2000 an index of formalism of legal procedure for two simple disputes: eviction of a non-paying tenant and collection of a bounced check. For a sub-sample of 40 countries, that authors compute this index every year starting in 1950, which allows them to study the evolution of legal rules. They find that between 1950 and 2000 the formalism of legal procedure did not converge, and possibly diverged, between common law and French civil law countries. At least in this specific area of law, the results are inconsistent with the hypothesis that national legal systems are converging, and support the view that legal origins exert long-lasting influence on legal rules. A revisited version of this paper was published in the August 2009 issue of The Amercian Economic Journal: Economic Policy. More...
Lionel Martellini Following recent research on the relevance of idiosyncratic risk in asset pricing models, this paper proposes to use total volatility as a model-free estimate of a stock's excess expected return, and analyze the implications in terms of the design of improved equity benchmarks. It finds that maximum Sharpe ratio portfolios consistent with such expected return proxies, and built upon improved estimates of the correlation parameters, significantly outperform market cap weighted schemes on a risk-adjusted basis. This analysis, which rehabilitates the role of the tangency portfolio from modern portfolio theory, suggests that better equity benchmarks can be designed, provided that a sophisticated portfolio optimization procedure is used that relies on robust estimates of moments and co-moments of stock return distributions. This paper has important potential implications for the ongoing debate on appropriate weighting schemes for equity indices. A revisited version of this paper was published in the Summer 2008 issue of the Journal of Portfolio Management. More...
Noël Amenc, Walter Géhin, Lionel Martellini, Jean-Christophe Meyfredi Following recent initiatives by major investment banks such as Merrill Lynch and Goldman Sachs, EDHEC researchers have undertaken a detailed critical analysis of the various methodologies involved in hedge fund replication offers, examining the benefits and limits of the “factor-based” and “pay-off” distribution approaches. In the study, “The Myths and Limits of Passive Hedge Fund Replication,” co-written by Lionel Martellini with Noël Amenc, Walter Géhin and Jean-Christophe Meyfredi, the authors find that overall, one could only possibly hope to achieve truly satisfying results by combining the best of the two competing approaches. A revisited version of this paper was published in the Fall 2008 issue of the Journal of Alternative Investments. More...
Noël Amenc, Véronique Le Sourd. Fund ratings are a widely used tool for fund promoters and fund subscribers. They serve to evaluate fund performance on a risk and return basis in an easily understandable way, and allow the performance of different funds to be compared. In this context, the quality and the robustness of the ratings is a critical subject for both investment management firms and investors. Though the predictive capability of fund ratings has not been proved, numerous studies performed on US mutual funds have concluded that fund subscribers are widely influenced by fund ratings in making their choice. A revisited version of this paper was published in the Summer 2007 issue of the Journal of Performance Measurement. More...
Lionel Martellini, Volker Ziemann This paper introduces a suitable extension of the Black-Litterman Bayesian approach to portfolio construction in the presence of non-trivial preferences about higher moments of asset return distributions. It also presents an application to active style allocation decisions in the hedge fund universe. Overall the results suggest that significant value can be added in a hedge fund portfolio through the systematic implementation of active style allocation decisions provided that a sound investment process is implemented that accounts for both non-normality and parameter uncertainty in hedge fund return distributions. A revisited version of this paper was published in the Summer 2007 issue of the Journal of Portfolio Management. More...
Lionel Martellini, Jean-Christophe Meyfredi This paper introduces a multivariate copula approach to Value-at-Risk estimation for fixed income portfolios. Using a parsimonious model to extract time-varying parameters used as proxies for factors affecting the shape of the yield curve, and a Student copula to model the dependence structure of these factors, we are able to generate VaR estimates that strongly dominate standard VaR estimates in formal out-of-sample tests. A revisited version of this paper was published in the Summer 2007 issue of the Journal of Fixed Income. More...
Noël Amenc, Felix Goltz Hedge fund indices have been criticised for a lack of representativity and for their biases, to the point that serious doubts about the usefulness of hedge fund indices have been raised by investors and regulators. This paper examines whether the problems that are outlined for hedge fund indices also exist for other indices that seem to be widely accepted. The drawbacks of hedge fund indices pointed out in the literature do indeed exist. However, in this paper, the authors point out that there are possible solutions to these problems. A revisited version of this paper was published in the Spring 2008 issue of the Journal of Alternative Investments. More...
Hilary Till. On September 18th, 2006, market participants were made aware of a large hedge fund’s distress. On that date, Nick Maounis, the founder of Amaranth Advisors, LLC, had issued a letter to his investors, informing them that the fund had lost an estimated 50% of their assets month-to-date. By the end of September 2006, these losses amounted to $6.6-billion, making Amaranth’s collapse the largest hedge-fund debacle to have thus far occurred. There were (and are) many surprising aspects of this debacle. A revisited version of this paper was published in the Spring 2008 issue of the Journal of Alternative Investments. More...
Xiafei Li, Chris Brooks, Joëlle Miffre The article analyses the impact of trading costs on the profitability of momentum strategies in the UK and concludes that losers are more expensive to trade than winners. The observed asymmetry in the costs of trading winners and losers crucially relates to the high cost of selling loser stocks with small size and low trading volume. Since transaction costs severely impact net momentum profits, the paper defines a new low-cost relative-strength strategy by shortlisting from all winner and loser stocks those with the lowest total transaction costs. A revisited version of this paper was published in the February 2009 issue of the Journal of Asset Management. More...
Rudy De Winne, Catherine D’Hondt This paper investigates why traders hide their orders and how other traders respond to hidden depth. Using a logit model, the authors provide empirical findings suggesting that traders use hidden orders to manage both exposure risk and picking off risk. Using probit models, they show that hidden depth increases order aggressiveness. The authors' interpretation of this empirical evidence is threefold. First, hidden depth detection is possible and frequent. Second, when traders detect hidden volume at the best opposite quote, they strategically adjust their order submission to seize the opportunity for depth improvement. A revisited version of this paper was published in the September 2007 issue of Review of Finance (formerly European Finance Review). More...
Xiafei Li, Chris Brooks, Joëlle Miffre Numerous studies have documented the failure of the static and conditional capital asset pricing models to explain the differences in returns between value and growth stocks. This paper examines the post-1963 value premium by employing a model that captures the time-varying total risk of the value-minus-growth portfolios. The results show that the conditional variance model incorporating time-varying idiosyncratic risk can fully capture the post-1963 value premium. The conclusion is robust to the criterion used to sort stocks into value and growth portfolios, to the inclusion of the size premium into the conditional asset pricing model, and to the country under review (US and UK). This paper therefore adds to the debate on the possible role of idiosyncratic risk in explaining equity returns. A revisited version of this paper was published in the November/December 2009 issue of the Journal of Business Finance and Accounting. More...
Joëlle Miffre, Georgios Rallis The article looks at the performance of 56 momentum and contrarian strategies in commodity futures markets. The authors build on the research of Erb and Harvey (2006) who focus on one momentum strategy. While contrarian strategies do not work, 13 momentum strategies are found to be profitable in commodity futures markets over horizons that range from 1 to 12 months. A revisited version of this paper was published in the June 2007 issue of the Journal of Banking and Finance. More...
Harry M. Kat, Joëlle Miffre This paper highlights the importance of non-normality risks and tactical asset allocation in assessing hedge fund performance. As such, it underlines the inaccuracies of previous papers on hedge fund performance that ignored higher moments in the distribution of hedge fund returns and assumed constant asset allocation. Correcting for these shortcomings, the authors find that failure to account for non-normality risks and tactical asset allocation on average leads to an overstatement of performance by 1.54% and to incorrect statistical inference on the performance of 1 out of 4 funds. On average, non-normality risks and conditional asset allocation explain 23.1% of the abnormal performance of hedge funds as commonly perceived. A revisited version of this paper was published in the Spring 2008 issue of the Journal of Alternative Investments. More...
Xiafei Li, Joëlle Miffre and Chris Brooks This article considers whether the widely documented momentum profits are a compensation for time-varying unsystematic risk as described by the family of autoregressive conditionally heteroscedastic models. The motivation for estimating a GJR-GARCH(1,1)-M model stems from the fact that, since losers have a higher probability than winners to disclose bad news, one cannot assume a symmetric response of volatility to good and bad news. A revisited version of this paper was published in the April 2008 issue of the Journal of Banking & Finance. More...
Walter Briec, Kristiaan Kersten, Octave Jokung This paper proposes a nonparametric efficiency measurement approach for the static portfolio selection problem in mean-variance-skewness space. A shortage function is defined that looks for possible increases in return and skewness and decreases in variance. Global optimality is guaranteed for the resulting optimal portfolios. We also establish a link to a proper indirect mean-variance-skewness utility function. For computational reasons, the optimal portfolios
resulting from this dual approach are only locally optimal. This framework makes it possible to differentiate between portfolio efficiency and allocative efficiency, and a convexity efficiency component related to the difference between the primal, non-convex approach and the dual, convex approach. Furthermore, in principle, information can be retrieved about the revealed risk
aversion and prudence of investors. An empirical section on a small sample of assets serves as an illustration. A revisited version of this paper was published in the January 2007 issue of Management Science. More...
Ana-Maria Fuertes, Joëlle Miffre and Wooi-Hou Tan This paper examines the role of non-normality risks in explaining the momentum puzzle of equity returns. It shows that momentum returns are not normally distributed. About 70 basis points of the annual momentum profits can be attributed to systematic skewness risk. This finding is pervasive across nine strategies and is reinforced when time dependencies in abnormal returns and risks are explicitly modeled. The analysis also reveals that the market and skewness risks of momentum portfolios evolve over the business cycle in a manner that is consistent with market timing and risk aversion. A revisited version of this paper was published in the June 2009 issue of Applied Financial Economics. More...
Daniel Giamouridis and Ioanna Ntoula This paper compares a number of different approaches for determining the Value at Risk (VaR) and Expected Shortfall (ES) of hedge fund investment strategies. The authors compute VaR and ES through completely model-free methods, as well as through mean/variance and distribution model-based methods. Among the models considered certain specifications can technically address autocorrelation, asymmetry, fat tails, and time-varying variances which are typical characteristics of hedge fund returns. They find that conditional mean/variance models coupled with appropriate distributional assumptions improve their ability to predict VaR, 1% VaR in particular. They also find that the goodness of ES prediction models is primarily influenced by the distribution model rather than the mean/variance specification. A revisited version of this paper was published in the March 2009 issue of the Journal of Futures Markets. More...
In a working paper entitled ‘Quantification of Hedge Fund Default Risk’, which led to the publication of a full article in the Fall issue of the Journal of Alternative Investments, Jean-René Giraud and Stéphane Daul of the EDHEC Risk and Asset Management Research Centre, together with co-author Corentin Christory, examined numerous cases of hedge fund default in order to find the common factors behind fund failures.
The objective of the paper was to provide an initial framework for quantifying the non-financial extreme risk of hedge funds with the aim of factoring it into the portfolio construction phase. The paper examines the statistical properties of hedge fund failures and attempts to identify essential risk factors that can tentatively explain why certain funds are more likely to default on their investors and creditors than others. A revisited version of this paper was published in the Fall 2006 issue of the Journal of Alternative Investments. More...
Transaction Cost Analysis
Jean-René Giraud, Catherine d’Hondt MiFID is the second step in the harmonization of the European capital markets industry and intends to adapt the first Investment Services Directive (ISD 1 issued in 1993) to the realities of the current market structures. After having clarified the nature of the new regulation, this paper first describes the role of Transaction Cost Analysis in the fulfilment of the best execution obligation as well as the limits of existing frameworks. Then, the paper presents a new methodology that makes it possible to measure the quality of execution as part of peer group review and identify whether the broker, trader or algorithm has implemented the execution too aggressively or too slowly. This approach relies on a couple of indicators allowing an easy comparison of a large universe of trades and providing insightful information not only about the final performance (EBEX absolute indicator) but also about the possible justification of the performance (EBEX direction). In order to illustrate both the framework and the level of interpretation made possible, the results of a preliminary study conducted on 2737 orders on Euronext blue chips over a 4-month sample period are reported. A revisited version of this paper was published in the November 2006 issue of the Journal of Asset Management. More...
John M Mulvey, Koray D. Simsek, Zhuojuan Zhang Over the past half-decade, pension plans in the US have seen their ample surpluses turn into massive deficits. Many pension trusts in early 2006 possess funding ratios below 75 per cent. This paper suggests that multi-period investment models can increase performance for long-term investors including pension plans, family offices and university endowments. The framework improves the investor's understanding of risks and rewards in a temporal setting. Contribution and saving strategies can be integrated with asset allocation decisions to enhance the sponsoring company's shareholder value via the pension trust. Applying an overlay strategy further improves performance. Advantages are illustrated via several examples, including the slow-growing telecommunication sector and the under-funded pension plan of a car company. This paper was published in the July 2006 issue of the Journal of Asset Management. More...
Hilary Till. This article, which was originally written as a two-part series, discusses the innovative ways in which academics and practitioners are enhancing asset allocation methodologies in order to incorporate hedge funds.
It begins by discussing the current practice in asset allocation work and goes on to describe the unique problems that occur when this methodology is applied to hedge funds. It also discusses a number of leading edge solutions to these problems. Included are anecdotes from anonymous hedge fund managers and traders, which illustrate some of the academic points made in the article. A revisited version of this paper was published in the GARP Risk Review, the Journal of the Global Association of Risk Professionals, September/October and November/December 2002 issues. More...
Hilary Till. Academic criticism of classic Capital Asset Pricing Model (CAPM) performance measures is not new. Until recently it was fine to use the Sharpe ratio as a way of summarizing the attractiveness of an investment. Only now have the shortcomings of using traditional performance measures to evaluate all manner of strategies become relevant to investors. This article touches on the problems with using traditional performance evaluation methods and summarize the state-of-the-art in alternative performance evaluation techniques. A revisited version of this paper was published in Quantitative Finance, (2002) 2:4 pp.237-238. More...
Hilary Till and Joseph Eagleeye. Given the ongoing stock market downdraft since March 2000, U.S. mutual fund inflows have dramatically slowed down while hedge fund investing has exploded. Some have argued that there is an accelerating convergence between the hedge fund industry and traditional institutional fund management. This article will argue the opposite: that in a very fundamental way, these two investment industries are still quite distinct. A revisited version of this paper was published in Quantitative Finance, (2003) 3:3 pp. C42-C48.
Hilary Till. A distinguishing feature in evaluating the risk of hedge fund strategies is the relative paucity of data, as noted by Feldman et al (2002). This creates great discomfort in attempting to apply statistical techniques to sparse datasets.
This article will discuss five further approaches that academics and practitioners have proposed since this summer for addressing the risk considerations that are unique to hedge funds. A revisited version of this paper was published in Quantitative Finance, (2002) 2:6 pp. 409-411.
Noël Amenc and Mathieu Vaissié. Despite institutional investors’ growing interest in funds of hedge funds, little attention has been paid so far to their added value and/or the sources of their added value. This is all the more striking in that funds of funds are far from transparent and are, with their double-fee structure, relatively costly investment vehicles. The objective in this paper is to fill that gap and find out whether funds of funds add value through strategic allocation and active management. A revisited version of this paper was published in the Winter 2006 issue of the Journal of Investing. More...
Rudy De Winne, Catherine D’Hondt This letter focuses on hidden orders and shows how they contribute to liquidity. Based on a rebuilt order book from Euronext data, the part of liquidity which is not disclosed to market participants is described and its determinants are analyzed. A revisited version of this paper was published in the July 2006 issue of Finance Letters. More...
Felix Goltz, Lionel Martellini, Volker Ziemann. In this paper, the authors examine how standard exchange-traded fixed-income derivatives (futures and options on futures contracts) can be included in a sound risk and asset management process so as to improve risk and return performance characteristics of managed portfolios. The results show that the non-linear character of the returns on protective option strategies offers appealing risk reduction properties in the pure asset management context. Consequently, such strategies should optimally receive a significant allocation, especially when investors are concerned with minimising extreme risks. A revisited version of this paper was published in the June 2006 issue of the Journal of Fixed Income.
Indexes & Benchmarking
Walter Géhin, Mathieu Vaissié The construction of an appropriate benchmark is one of the major challenges of the performance measurement process. Without quality benchmarks, it is not possible to differentiate between returns due to the investment style of the manager and returns due to the talent of the manager, which in turn makes it difficult to measure relative returns. This paper examines the issue of hedge fund strategy benchmarks in the light of improvements in hedge fund index construction methodologies and management principles, and with the launch of new series of investable hedge fund indices. The paper notably tries to answer the following question: Can investors in the alternative arena measure the relative returns of hedge funds? A revisited version of this paper was published in the May-June 2005 issue of the Journal of Indexes. More...
Joëlle Miffre The article shows that country-specific exchange-traded funds (ETFs) enhance global asset allocation strategies. Because ETFs can be sold short even on a downtick, global strategies that diversify risk across country-specific ETFs generate efficiency gains that cannot be achieved by simply investing in a global index open- or closed-end fund. Besides, the benefits of international diversification can be achieved with country-specific ETFs at low cost, with low tracking error and in a tax-efficient way. For all these reasons, country-specific ETFs may be considered serious competitors to traditional country open and closed-end funds. A revisited version of this paper was published in the March 2007 issue of the Journal of Asset Management. More...
Francois-Serge Lhabitant, Denis Mirlesse, Michel Chardon The first few years of the 2000s have been characterized by a magnified and explicit return to the investment approach that is now widely known as ‘absolute return.’ In this article, we discuss the practical steps to implement an absolute return strategy in equity markets, by first unbundling alpha from beta in the portfolio, then optimising the beta component by choosing the most efficient index tracking method, and finally applying the most appropriate dynamic risk budgeting technique to the indexation. This paper was published in the April 2006 issue of the Journal of Financial Transformation. More...
Noël Amenc, Philippe Malaise, Mathieu Vaissié The development of alternative investment has not yet been accompanied by a genuine consideration of the specific characteristics of the risks and returns of hedge funds with regard to the provision of information to investors. This inadequacy came to light in a study published by EDHEC in 2003, a study that showed that a very large majority of European hedge fund managers were satisfied with a reporting method designed for investment in traditional asset classes. This method proposes a mean variance-structure that is inappropriate for the risk and return profiles of alternative investment and does not inform investors of extreme risk and risk factors affecting the different returns of the hedge fund strategies in which the funds of funds are invested. To address
this issue, in 2004, EDHEC launched, an international consultation process for the implementation of a new framework for funds of hedge funds reporting. A revisited version of this paper was published in the Journal of Risk Finance, 1st Quarter 2006. More...
Hilary Till. Hedge funds do not easily fit into the current way institutions go about investing. In this article, the author reviews both academic and practitioner research from the standpoint of a hypothetical institutional investor who is looking into whether hedge funds make sense for their portfolio. A revisited version of this paper was published in the Spring 2004 issue of The Journal of Alternative Investments. More...
Hilary Till, Joseph Eagleeye. In this article, the authors note how a set of active commodity strategies could potentially add value to an investor’s commodity allocation. But they also emphasize the due care that must be taken in risk management and implementation discipline, given the “violence of the fluctuations which normally affect the prices of many … commodities,” as Keynes (1934) put it. A revisited version of this paper was published in the Fall 2005 issue of The Journal of Wealth Management. More...
Jakša Cvitanic, Ali Lazrak, Lionel Martellini, Fernando Zapatero. In this paper, the authors derive a closed-form solution for the optimal portfolio of a non-myopic utility maximizer who has incomplete information about the “alphas”, or abnormal returns of risky securities. They show that the hedging component induced by learning about the expected return can be a substantial part of our demand. A revisited version of this paper was published in the Winter 2006 issue of the Review of Financial Studies. More...
Hilary Till, Jodie Gunzberg. In this article, the authors provide the busy reader with a survey of articles that were written over the past four years on hedge funds. Specifically, they review the economic basis for hedge fund returns and then discuss some of the logical consequences of these observations. Next, they summarize the general statistical properties of hedge fund strategies. They then examine what the appropriate performance measurement and risk management techniques are for these investments. And lastly, they briefly cover ways that investors can consider incorporating hedge funds within their overall portfolios. A revisited version of this paper was published in the Winter 2005 issue of the Journal of Wealth Management. More...
Barry Feldman, Hilary Till. In this paper, the authors examine the role of backwardation in the performance of passive long positions in soybeans, corn and wheat futures over the period of 1950 to 2004. They find that over this period, backwardation has been highly predictive of the return of a passive long futures position when measured over long investment horizons. The share of return variance explained by backwardation rises from 24% at a one-year horizon to 64% using five-year time periods. A revisited version of this paper was published in the Winter 2006 issue of the Journal of Alternative Investments. More...
John M. Mulvey, Frank J. Fabozzi, William R. Pauling, Koray D. Simsek, Zhuojuan Zhang The defined–benefit pension system may not survive into the future absent changes in the current regulatory environment. A risk–based and anticipatory approach to evaluating pension trusts is proposed as a way to diminish the probability that large and insolvent companies will transfer their pension trusts to the Pension Benefit Guaranty Corporation. Because current difficulties are concentrated in a few industries, there will be severe problems in the future if the healthiest companies reduce their exposure to defined–benefit pensions. This paper was published in the Winter 2005 issue of the Journal of Portfolio Management. More...
Lionel Martellini, Volker Ziemann Institutional investors in general and pension funds in particular have been dramatically affected by negative stock market returns at the beginning of the millennium. In the context of a cumulative asset/liability deficit that was estimated at more than £55 billion in 2003 for the companies in the FTSE 100,
institutional investors are seeking new asset classes or forms of investment management that would allow them to broaden their traditional choice of asset allocation. An alternative investment offering has been introduced in the past several years, allowing investors to optimise the risk/return combination of their portfolio. A revisited version of this study was published in the June 2006 issue of The IFCAI Journal of Financial Risk Management. More...
Daniel Capocci Using an original database of 634 market neutral hedge funds, this study formally analyses the market neutrality of market neutral funds which are particular in the hedge fund universe since the only objective of these funds is to provide positive returns completely independent of the market conditions. We start by analysing this neutrality using various market neutral indices before focusing on individual fund returns. Finally, an analysis based on ex-post beta helps us explaining and confirming our previous results. We perform this analysis over the global January 1993- December 2002 period as well as on bull and bear market periods. A revisited version of this paper was published in the December 2006 issue of the Global Finance Journal. More...
Lionel Martellini, Branko Uroševic In this paper, we generalize Markowitz analysis to the situations involving an uncertain exit time. Our approach preserves the form of the original problem in that an investor minimizes portfolio variance for a given level of the expected return. However, inputs are now given by the generalized expressions for mean and variance-covariance matrix involving moments of the random exit time in addition to the conditional moments of asset returns. While efficient frontiers in the generalized and the standard Markowitz case may coincide under certain conditions, we demonstrate, by means of an example, that in general that is not true. In particular, portfolios efficient in the standard Markowitz sense can be inefficient in the generalized sense and vice versa. As a result, an investor facing an uncertain time-horizon and investing as if her time of exit is certain would in general make sub-optimal portfolio allocation decisions. Numerical simulations show that a significant efficiency loss can be induced by an improper use of standard mean-variance analysis when time-horizon is uncertain. A revisited version of this paper was published in the June 2006 issue of Management Science.
Walter Géhin, Mathieu Vaissié Two studies, by Watson Wyatt and UBS (both from March 2005), give a pessimistic view of the hedge fund industry’s capacity to generate long-term returns, due to its increasing size. Unfortunately, these studies focus almost exclusively on alpha. In the present paper, we show the importance of considering not only the exposure to the market (the traditional beta), but also the other exposures (the alternative betas) to cover all the sources of hedge fund returns. To do so, we examine the real extent to which the variability and level of hedge fund returns are affected by (static) betas, dynamic betas (i.e. factor timing), and pure alpha (i.e. security selection). A revisited version of this study was published in the Summer 2006 issue of The Journal of Alternative Investments.
Frank J. Fabozzi, Lionel Martellini, Philippe Priaulet This paper presents evidence of predictability in the time-varying shape of the U.S. term structure of interest rates using a robust recursive modelling approach based on a Bayesian mixture of multi-factor models. We find that variables such as default spread, equity volatility, short-term and forward rates, among others, can be used to predict changes in the slope of the yield curve, and also, albeit to a lesser extent, changes in the curvature of the yield curve. By using systematic trading strategies based on butterfly swaps, we also find that this evidence of predictability in the shape of the yield curve is economically significant in addition to being statistically significant. A revisited version of this paper was published in the June 2005 issue of the Journal of Fixed Income. More...
Noël Amenc, Philippe Malaise, Lionel Martellini In this paper, "From Delivering to the Packaging of Alpha. Illustration from Active Bond Portfolio Management: Using Fixed-Income Derivatives to Design Hedge Fund Type Offerings that Better Fit Investors’ Needs", the authors emphasize the need for the hedge fund industry to adopt a consumer (investor)-driven approach, as opposed to the current producer (manager) perspective, and call for the emergence of new types of offering with characteristics better suited to the needs of institutional investors. Using active bond portfolio management as an example, they present evidence on the use of derivatives by managers for generating and delivering abnormal performance, and also for packaging such performance in a form that is consistent with the modern core-satellite approach to institutional portfolio management, for which they explore both a standard static version and also a dynamic extension allowing for dissymmetric control of active management risk. A revisited version of this paper was published in the Winter 2006 issue of the Journal of Portfolio Management. More...
François-Serge Lhabitant The delegation of asset management services is a source of potential agency problems between investors and their portfolio managers. Most of these problems can be avoided by using an adequate compensation theme. While the academic literature tends to be somewhat inconclusive as to whether or not, and to what degree optimal compensation should be linked to relative or absolute performance, industry practice seems to show a clear pattern: mutual funds charge an asset-based fee, while hedge funds charge both an asset-based fee and a performance fee. In this article, the author discusses the advantages and drawbacks of both types of fees. A revisited version of this paper was published in The Journal of Financial Transformation. More...
In 2004, Edhec launched an international consultation process on the implementation of a new framework for Funds of Hedge Funds reporting. This consultation process was based on a series of recommendations proposed by Edhec with regard to the academic state-of-the-art on risk measurement in the alternative universe. The results of this consultation were presented to a panel of journalists on February 17th in London at a meeting hosted by FIMAT. A revisited version of this study was published in The Journal of Risk Finance, 1st Quarter 2006. More...
Lionel Martellini, Mathieu Vaissié, Felix Goltz Following a growing concern among investors about the quality of hedge fund index return data, and given the lack of capacity and transparency specific to that industry, this paper questions from an academic perspective whether it is feasible or not to design hedge fund benchmarks satisfying all defining properties for a good index. In particular, in an attempt to test whether achieving investability necessarily comes at the cost of representatitivity, as sometimes claimed by hedge fund index providers, we borrow from the asset pricing literature the concept of factor replicating portfolios and apply it to the benchmarking of hedge fund style returns. A revisited version of this paper was published in the March 2007 issue of European Financial Management. More...
Christophette Blanchet-Scalliet, Nicole El Karoui, Lionel Martellini This paper addresses the problem of pricing and hedging a random cash-flow received at a random date in a general stochastic environment. We first argue that specific timing risk is induced by the presence of an uncertain time-horizon if and only if the random time under consideration is not a stopping time of the filtration generated by prices of traded assets. In that context, we provide an explicit characterization of the set of equivalent martingale measures, as well as a necessary and sufficient condition for a convenient separation between adjustment for market risk and timing risk. A revisited version of this paper was published in the October 2005 issue of the Journal of Economic Dynamics and Control. More...
Noël Amenc, Philippe Malaise, Lionel Martellini, Daphné Sfeir It has long been argued that equity managers can use derivatives markets to help implement a systematic risk management process designed to enhance the performance of their portfolio (see for example Ineichen (2002) for a recent reference). These derivatives instruments can be used in the context of completeness portfolios that are designed not to interfere with the original portfolio composition, so that they can be used to generate what have been labeled portable beta benefits (Amenc et al. (2004)). Consider for example the case of long/short equity hedge fund managers. A revisited version of this paper was published in the Winter 2004 issue of Economic & Financial Computing. More...
Noël Amenc, Jean-René Giraud, Lionel Martellini, Mathieu Vaissié Over the last few years institutional investors’ traditional portfolios have failed to meet their objectives in terms of risk and performance. Investors have thus shown growing interest in new forms of diversification, especially in investment vehicles that offer better protection during extreme market conditions. A revisited version of this paper was published in the Winter 2004 issue of the Journal of Alternative Investments. More...
Noël Amenc, Philippe Malaise, Lionel Martellini Tracking error is not necessarily bad. Just like with good and bad cholesterol, there is “good” tracking error, which refers to out-performance of a portfolio with respect to the benchmark, and “bad” tracking error, which refers to underperformance with respect to the benchmark. By severely restricting the amounts invested in active strategies as a result of tight tracking error constraints, investors forgo an opportunity for significant out-performance, especially during market downturns. In this paper, the authors introduce a new methodology that allows investors to gain full access to good tracking error, while maintaining the level of bad tracking error below a given threshold. A revisited version of this paper was published in the Fall 2004 issue of The Journal of Portfolio Management. More...
François-Serge Lhabitant There is an increasing amount of evidence that shows the benefits of considering hedge funds as an asset class at the strategic asset allocation level. The investors’ greatest challenge remains the identification of desirable investment vehicles, since very little formal quantitative analysis of hedge funds has been done in the past. In this paper, we suggest an innovative approach to hedge fund investing, which is valid at the individual fund level as well as at the aggregate portfolio level (e.g. portfolio of hedge funds). This approach only relies on hedge funds historical returns. We provide several illustrations, including static and dynamic style analysis, benchmark construction, performance assessment, and value at risk calculations. A revisited version of this paper was published in the Journal of Financial Transformation, nº 1. More...
François-Serge Lhabitant, Michelle Learned De Piante Vicin Hedge funds are often thought of as being high-risk investments and many investors in the past have shied away from them for fear of making large losses. However, over the recent years, hedge funds have generally substantially outperformed equities, with much lower volatility. As a consequence, they are now in strong demand, particularly when one remembers that any risk associated with hedge fund investing diminishes in importance when the funds are repackaged into fund of funds products. A revisited version of this paper was published in the April 2004 issue of the Journal of Financial Transformation. More...
Noël Amenc, Philippe Malaise, Lionel Martellini, Daphne Sfeir In this paper, we show how portfolio managers in the
Euro-zone can benefit from using derivatives markets to actively manage their asset allocation decisions
in a systematic manner. Using a robust econometric process based on a non-linear multi-factor thick and
recursive modeling approach, we report statistically and economically significant evidence of predictability
in Dow Jones EURO STOXX 50 excess return. These econometric forecasts can be turned into active portfolio decisions and implemented via Eurex index futures to generate active asset allocation portable alpha benefits. A revisited version of this paper was published in the Summer 2004 issue of The Journal of Portfolio Management. More...
Noël Amenc, Anne Delaunay, Jean-René Giraud, Felix Goltz, Lionel Martellini, Mathieu Vaissié On 11th December 2003 in Paris, Edhec presented the results of its survey on alternative multimanagement in Europe, the Edhec European Alternative Multimanagement Practices survey.
This study, sponsored by FIMAT, is based both on a review of all the professional and academic research on alternative investment and a survey of the practices of European multimanagers, to which 61 firms (investors, advisors and funds of funds) replied, representing a total of 136 billion euros under management. The key findings of this study were published in the March 2004 issue of The Journal of Financial Transformation.
Noël Amenc, Philippe Malaise, Lionel Martellini, Daphne Sfeir Even though there is little evidence of predictability in stock specific risk in the absence of private information, most equity market neutral managers still rely on stock picking as the preferred way to generate abnormal returns. In this paper, we document the benefits of a new form of market-neutral portfolio strategy that aims at deliver absolute return over the full business cycle through systematic equity style timing decisions. A revisited version of this paper was published in the Summer 2003 issue of the Journal of Alternative Investments. More...
Noël Amenc, Daphne Sfeir, Lionel Martellini
In this paper, we propose an integrated framework for assessing the risk-adjusted performance of
mutual fund managers. The methodology is designed so as to be consistent not only with modern
portfolio theory but also with constraints imposed by practical implementation in a context where
the presence of a variety of investment styles needs to be accounted for. A revisited version of this paper was published in the Summer 2003 issue of the Journal of Performance Measurement.
Jaksa Cvitanic, Ali Lazrak, Lionel Martellini and Fernando Zapatero
What percentage of their portfolio should investors allocate to hedge funds? The
only available answers to the above question are set in a static mean-variance framework,
with no explicit accounting for uncertainty on the active manager’s ability to generate abnormal return, and usually generate unreasonably high allocations to hedge funds.
In this paper, we apply the model introduced in Cvitanic, Lazrak, Martellini and Zapatero
(2002) for optimal investment strategies in the presence of uncertain abnormal returns
to a database of hedge funds. Wefind that the presence of model risk significantly
decreases an investor’s optimal allocation to hedge funds. Another finding of this
paper is that low beta hedge funds may serve as natural substitutes for a significant
portion of an investor risk-free asset holdings. A revisited version of this paper was published in the February 2003 issue of Quantitative Finance. More...
Noël Amenc, Lionel Martellini
This paper attempts to evaluate the out-of-sample performance of an improved estimator
of the covariance structure of hedge fund index returns, focusing on its use for optimal
portfolio selection. A revisited version of this paper was published in the Fall 2002 issue of the Journal of Alternative Investments. More...
Noël Amenc, Sina El Bied, Lionel Martellini
While there has been a significant amount of research on the predictability of traditional
asset classes, very little is known about the predictability of returns emanating from alternative vehicles such as hedge funds. This paper attempts to fill this gap by documenting evidence of predictability in hedge fund returns. A revisited version of this paper was published in the September/October 2003 issue of the Financial Analysts Journal. More...
Noël Amenc, Lionel Martellini, Mathieu Vaissié
The growth of alternative investment has been considerable in recent years. For both institutional and private investors, it seems that alternative investment now constitutes a distinct class within their overall asset allocation. A revisited version of this paper was published in the July 2003 issue of the Journal of Asset Management. More...
Laurent Favre, José-Antonio Galeano Based on the normal Value-at-Risk, we develop a new Value-at-Risk method called Modified Value-at-Risk. This Modified Value-at-Risk has the property to adjust the risk, measuring with
the volatility only, with the skewness and the kurtosis of the distribution of returns. The Modified
Value-at-Risk allows to measure first the risk of portfolio with assets non normally distributed
like hedge funds or technology stocks and to compute optimal portfolio by minimizing the
Modified Value-at-Risk at a given confidence level. A revisited version of this paper was published in the Autumn 2002 issue of the Journal of Alternative Investments. More...
Laurent Favre, Andreas Signer In this paper, the use mean-variance approach for the determination of the benefits of allocations
to hedge funds is critically evaluated. The advantages of investing in hedge funds are often
explained and demonstrated with reference to a shift in the efficiency frontier of traditional
portfolios. The added value of hedge funds is almost always indicated in a mean-standard
deviation environment and should in our view be reconsidered. The estimated risk exposure can
be quantified by the introduction of Value-at-risk analysis corrected according to higher moments
of distribution. With this new risk measure, we are able to obtain a corrected value. A revisited version of this paper was published in the Summer 2002 issue of the Journal of Alternative Investments. More...
Laurent Favre, José-Antonio Galeano In this article, we analyze the returns distribution of Hedge Funds strategies, the average returns
obtained over the past ten years and their correlation with a traditional portfolio. The aim is to
identify the characteristics of each Hedge Fund investment strategy in order to be able to
construct an optimal Hedge Fund portfolio for a Swiss pension fund. We will show that the
classical linear correlation and the classical linear regression cannot be applied for Hedge Funds.
Moreover, we will show that only three strategies, Convertible Arbitrage, Market Neutral and
CTA, give diversification during market downturns. The techniques used are non-linear
regressions and local correlations. A revisited version of this paper was published in the Spring 2002 issue of the Journal of Alternative Investments. More...
Noël Amenc, Lionel Martellini Despite repeated evidence that asset allocation accounts for a very large fraction of a portfolio return, the industry has never stopped favouring stock picking as the preferred form of active investment strategy. In this paper, we attempt to rehabilitate the importance of active asset allocation in the investment process. A revisited version of this paper was published in the December 2001 issue of the Journal of Financial Transformation. More...
François-Serge Lhabitant Under the efficient market hypothesis, overwriting calls or purchasing
insurance should not improve risk-adjusted portfolio returns. A proper analysis
should show that if options are traded at a fair cost, the risk-reward characteristics
of an option position would fall on the efficient market line. In this paper we
show that, due to several limitations of mean-variance analysis, this is not the
case in practice. We quantify and identify the nature of the resulting biases for
performance evaluation, and explain why alternative measures such as semi
variance do not help in avoiding such biases. A revisited version of this paper was published in the Winter, 7(2) issue of Derivatives Quarterly. More...
|EDHEC-Risk Alternative Indexes: May 2013 (Estimates)
|EDHEC-Risk IEIF Commercial Property: May 2013