EDHEC-Risk - Academic Publications

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Alternative Investments

Extending Black-Litterman Analysis Beyond the Mean-Variance Framework

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...

01/10/07

Risk Management

A Copula Approach to Value-at-Risk Estimation for Fixed-Income Portfolios

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...

01/10/07

Order Execution

Hide-and-Seek in the Market: Placing and Detecting Hidden Orders

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 Review of Finance (formerly European Finance Review). More...

09/05/07

Alternative Investments

Momentum Strategies in Commodity Futures Markets

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...

04/04/07

Alternative Investments

Quantification of Hedge Fund Default Risk

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...

24/01/07

Alternative Investments

Determinants of Funds of Hedge Funds’ Performance

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...

27/07/06

Asset Allocation

Derivatives Strategies for Bond Portfolios

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. More...

21/06/06

Indexes & Benchmarking

Hedge Fund Strategy Benchmarks: Tricks of the Light or Lighthouses?

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...

01/06/06

Asset Allocation

Dynamic Portfolio Choice with Parameter Uncertainty and the Economic Value of Analysts’ Recommendations

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...

23/03/06

Asset-Liability Management

The Benefits of Hedge Funds in Asset Liability Management

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...

05/10/05

Asset Allocation

Static Mean-Variance Analysis with Uncertain Time Horizon

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. More...

01/07/05

Alternative Investments

The Right Place for Alternative Betas in Hedge Fund Performance: An Answer to the Capacity Effect Fantasy

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. More...

13/06/05

Fixed-Income Strategies

Exploiting Predictability in the Time-Varying Shape of the Term Structure of Interest Rates

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...

01/06/05

Derivatives

From Delivering to the Packaging of Alpha

N. Amenc, L. Martellini, P. Malaise. 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...

23/05/05

Alternative Investments

Edhec Funds of Hedge Funds Reporting Survey

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...

08/03/05

Indexes

Hedge Fund Indices from an Academic Perspective: Reconciling Investability and Representativity

L. Martellini, M. Vaissié, F. 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...

09/11/04

Asset Pricing

Dynamic Asset Pricing Theory with Uncertain Time-Horizon

C. Blanchet-Scalliet, N. El Karoui, L. 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...

08/11/04

Asset Allocation

Using Index Options to Improve the Performance of Dynamic Asset Allocation Strategies

N. Amenc, P. Malaise, L. Martellini, D. 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...

22/10/04

Business Analysis

Taking a Close Look at the European Fund of Hedge Funds Industry - Comparing and Contrasting Industry Best Practices and Academic Recommendations

N. Amenc, J.R. Giraud, L. Martellini, M. 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...

22/09/04

Asset Allocation

Revisiting Core-Satellite Investing - A Dynamic Model of Relative Risk Management

N. Amenc, P. Malaise, L. 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...

22/09/04

Hedge Funds

Finding the Sweet Spot of Hedge Fund Diversification

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...

27/04/04

Asset Allocation

Portable Alpha and Portable Beta Strategies in the Euro Zone - Implementing Active Asset Allocation Decisions using Equity Index Options and Futures

N. Amenc, P. Malaise, L. Martellini, D. 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...

08/01/04

Alternative Investments

Edhec European Alternative Multimanagement Practices Survey

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. More...

17/12/03

Tactical Allocation

Tactical Style Allocation - A New Form of Market Neutral Strategy

Noël Amenc, Philippe Malaise, Lionel Martellini and 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...

15/07/03

Performance

An Integrated Framework for Style Analysis and Performance Measurement

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. More...

28/02/03

Tactical Allocation

Evidence of Predictability in Hedge Fund Returns

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...

13/11/02

Alternative Investments

Benefits and Risks of Alternative Investment Strategies

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...

04/11/02


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