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Forecasting the performance of hedge fund styles

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  • Olmo, José
  • Sanso-Navarro, Marcos

Abstract

This article predicts the relative performance of hedge fund investment styles using time-varying conditional stochastic dominance tests. These tests allow for the construction of dynamic trading strategies based on nonparametric density forecasts of hedge fund returns. During the recent financial turmoil, our tests predict a superior performance for the Global Macro investment style compared with the other strategies of ‘Directional Traders’. The Dedicated Short Bias investment style is stochastically dominated by the other directional styles. These results are confirmed by simple nonparametric tests constructed from realized excess returns. Further, by utilizing a cross-validation method for optimal bandwidth parameter selection, we discover the factors that have predictive power regarding the density of hedge fund returns. We observe that different factors have forecasting power for different regions of the returns distribution and, more importantly, that the Fung and Hsieh factors have power not only for describing the risk premium but also, if appropriately exploited, for density forecasting.

Suggested Citation

  • Olmo, José & Sanso-Navarro, Marcos, 2012. "Forecasting the performance of hedge fund styles," Journal of Banking & Finance, Elsevier, vol. 36(8), pages 2351-2365.
    • Handle: RePEc:eee:jbfina:v:36:y:2012:i:8:p:2351-2365
    DOI: 10.1016/j.jbankfin.2012.04.016
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    Cited by:

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    3. Laborda, Ricardo, 2018. "Optimal combination of currency strategies," The North American Journal of Economics and Finance, Elsevier, vol. 43(C), pages 129-140.

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    More about this item

    Keywords

    Conditional density estimation; Hedge fund styles; Nonparametric methods; Portfolio performance; Stochastic dominance tests;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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