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The Necessity to Correct Hedge Fund Returns: Empirical Evidence and Correction Method

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  • Georges Gallais-Hamonno
  • Huyen Nguyen-Thi-Thanh

Abstract

We study two principal mechanisms suggested in the literature to correct the serial correlation in hedge fund returns and the impact of this correction on financial characteristics of their returns as well as on their risk level and on their performances. The methods of Geltner (1993), its extension by Okunev & White (2003) and that of Getmansky, Lo & Makarov (2004) are applied on a sample of 54 hedge fund indexes. The results show that the unsmoothing leaves the mean unchanged but increases significantly the risk level of hedge funds, whether the risk is measured in terms of the return standard-deviation or the modified VaR. Funds' absolute performances, measured by traditional Sharpe ratio and Omega index, decline considerably. By contrast, funds' rankings after the unsmoothing unexpectedly change slightly. However, some notable modifications in ranks of several funds are observed. The necessary transparency of the management practice requires that such a correction must be systematically done.

Suggested Citation

  • Georges Gallais-Hamonno & Huyen Nguyen-Thi-Thanh, 2007. "The Necessity to Correct Hedge Fund Returns: Empirical Evidence and Correction Method," Working Papers CEB 07-034.RS, ULB -- Universite Libre de Bruxelles.
    • Handle: RePEc:sol:wpaper:07-034
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    References listed on IDEAS

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    1. William F. Sharpe, 1965. "Mutual Fund Performance," The Journal of Business, University of Chicago Press, vol. 39, pages 119-119.
    2. David M. Geltner, 1993. "Estimating Market Values from Appraised Values without Assuming an Efficient Market," Journal of Real Estate Research, American Real Estate Society, vol. 8(3), pages 325-346.
    3. 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.
    4. 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.
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    Cited by:

    1. M. Glawischnig & I. Seidl, 2013. "Portfolio optimization with serially correlated, skewed and fat tailed index returns," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 21(1), pages 153-176, January.

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    More about this item

    Keywords

    hedge funds; smoothed returns; performance evaluation; Sharpe ratio; Omega index.;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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