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Evaluating hedge fund performance: a stochastic dominance approach

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  • Sheng Li
  • Oliver Linton

Abstract

We introduce a general and flexible framework for hedge fund performance evaluation and asset allocation: stochastic dominance (SD) theory. Our approach utilizes statistical tests for stochastic dominance to compare the returns of hedge funds. We form hedge fund portfolios by using SD criteria and examine the out-of-sample performance of these hedge fund portfolios. Compared to performance of portfolios of randomly selected hedge funds and mean-variance efficient hedge funds, our results show that fund selection method based on SD criteria greatly improves the performance of hedge fund portfolio.Keywords: Alpha; Mean Variance analysis; Portfolio; Risk Return

Suggested Citation

  • Sheng Li & Oliver Linton, 2007. "Evaluating hedge fund performance: a stochastic dominance approach," FMG Discussion Papers dp591, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp591
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    References listed on IDEAS

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    1. Getmansky, Mila & Lo, Andrew W. & Makarov, Igor, 2004. "An econometric model of serial correlation and illiquidity in hedge fund returns," Journal of Financial Economics, Elsevier, vol. 74(3), pages 529-609, December.
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    11. Amin, Gaurav S. & Kat, Harry M., 2003. "Hedge Fund Performance 1990–2000: Do the “Money Machines” Really Add Value?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(2), pages 251-274, June.
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    Cited by:

    1. Guo, Dongmei & Hu, Yi & Wang, Shouyang & Zhao, Lin, 2016. "Comparing risks with reference points: A stochastic dominance approach," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 105-116.

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    More about this item

    Keywords

    alpha; mean variance analysis; portfolio; risk return;
    All these keywords.

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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