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Stocks, Bond and Hedge Funds: Not a Free Lunch

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  • Gaurav Amin

    (ICMA Centre, University of Reading)

  • Harry. M Kat

    (ICMA Centre, University of Reading)

Abstract

We study the diversification effects from introducing hedge funds into a traditional portfolio of stocks and bonds. Our results make it clear that in terms of skewness and kurtosis equity and hedge funds do not combine very well. Although the inclusion of hedge funds may significantly improve a portfolio's mean-variance characteristics, it can also be expected to lead to significantly lower skewness as well as higher kurtosis. This means that the case for hedge funds includes a definite trade-off between profit and loss potential. Our results also emphasize that to have at least some impact on the overall portfolio, investors will have to make an allocation to hedge funds which by far exceeds the typical 1-5% that many institutions are currently considering.

Suggested Citation

  • Gaurav Amin & Harry. M Kat, 2002. "Stocks, Bond and Hedge Funds: Not a Free Lunch," ICMA Centre Discussion Papers in Finance icma-dp2002-11, Henley Business School, University of Reading.
    • Handle: RePEc:rdg:icmadp:icma-dp2002-11
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    File URL: http://www.icmacentre.ac.uk/pdf/discussion/DP2002-11.pdf
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    References listed on IDEAS

    as
    1. Chris Brooks & Harry. M Kat, 2001. "The Statistical Properties of Hedge Fund Index Returns," ICMA Centre Discussion Papers in Finance icma-dp2001-09, Henley Business School, University of Reading.
    2. Jean, William H., 1973. "More on Multidimensional Portfolio Analysis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 8(3), pages 475-490, June.
    3. Simkowitz, Michael A. & Beedles, William L., 1978. "Diversification in a Three-Moment World," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(5), pages 927-941, December.
    4. Jean, William H., 1971. "The Extension of Portfolio Analysis to Three or More Parameters," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 6(1), pages 505-515, January.
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    Cited by:

    1. Boyson, Nicole M. & Stahel, Christof W. & Stulz, Rene M., 2006. "Is There Hedge Fund Contagion?," Working Paper Series 2006-1, Ohio State University, Charles A. Dice Center for Research in Financial Economics.

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