EDHEC Publications
Shedding Light on Alternative Beta : A Volatility and Fixed Income Asset Class Comparison
2007
Volatility is an alternative beta—a risk premium captured by hedge fund managers and investment bank proprietary traders—that is today moving closer to the mainstream and should be thought of as a veritable asset class. For many investors, it is difficult to derive intuition as to why volatility should deserve an ongoing allocation within a larger portfolio. If volatility is an asset class, then to what accepted asset class can it be compared?
Approximating Independent Loss Distributions with an Adjusted Binomial Distribution
2007
The author describes an approximation methodology for constructing independent loss distributions based on adjusting the binomial distribution. This method can handle both homogeneous and heterogeneous loss portfolios. He finds that this simple algorithm provides an excellent fit to the exact distribution for a broad range of correlations and portfolio credit quality.
Equity Hedge Fund ABS Models: Choosing the Volatility Factor
2007
The use of asset-based style analysis (ABS) in the context of hedge fund investments continues to take hold within the industry. Many of the factors used in performing this analysis are straightforward and well-accepted—particularly in the area of equity hedge funds, where a long market index factor, a small-minus-large factor, and a value-minus growth factor seem to be well-accepted components of an equity hedge fund ABS model. Little attention, however, has been given to understanding the most relevant volatility factors and the relative merits of various instruments in this context.
New Developments in the Commodity Markets
2007
In 2007, the highly dynamic commodity markets had attracted new classes of participants such as algorithmic high-frequency traders; sophisticated product structurers; and Chinese entrepreneurs. This article will briefly cover the market developments that brought in these new participants.
The Myths and Limits of Passive Hedge Fund Replication: An Attractive Concept… Still a Work-in-Progress
2007
Following recent initiatives by major investment banks such as Merrill Lynch and Goldman Sachs, EDHEC researchers have undertaken a detailed critical analysis of the various methodologies involved in hedge fund replication offers, examining the benefits and limits of the “factor-based” and “pay-off” distribution approaches. In the study, “The Myths and Limits of Passive Hedge Fund Replication,” co-written by Lionel Martellini with Noël Amenc, Walter Géhin and Jean-Christophe Meyfredi, the authors find that overall, one could only possibly hope to achieve truly satisfying results by combining...
QIS3: Meaningful progress towards the implementation of Solvency II but ground remains to be covered
2007
This document outlines our position on the third quantitative impact survey on the standard formula for the calculation of capital requirements for insurance companies under Solvency II. Before reviewing the principles that underlie the standard formula, we will give a brief introduction to Solvency II. In light of this introduction, we will then review the changes that QIS3 has brought about in the design of Solvency II; we will also point out major improvements as well as changes that are inconsistent with the very principles of this body of regulations.
Conditional Risk Premia and Correlations in Commodity Futures Markets
2007
In this paper, the authors study the conditional risk premia of commodity futures and the way their returns vary over time with those of traditional asset classes (S&P500 stocks and US T-bonds). They draw the following two conclusions. First, that historically investors earned significant risk premia on 19 of the 21 commodity futures markets studied. Second, that the conditional correlations between equity and commodity futures returns fell over time.
Hedge Fund Performance in 2006: A Vintage Year for Hedge Funds?
2007
In a report entitled “Hedge Fund Performance: A Vintage Year for Hedge Funds?”, Véronique Le Sourd, Senior Research Engineer with the EDHEC Risk and Asset Management Research Centre provides a comprehensive account of the performance of each hedge fund strategy included in the EDHEC Alternative Indexes. The author reveals that funds of hedge funds, which are often taken to give an aggregate view of the industry’s performance, yielded a solid return of 11.25% in 2006.
A Review of the U.S. Senate Report on the Amaranth Debacle
2007
This paper summarises what the U.S. Senate Permanent Subcommittee on Investigations' report on the Amaranth debacle covered, and briefly touches upon important areas that the report omitted.
State Dependence Can Explain the Risk Aversion Puzzle
2007
Risk aversion functions extracted from observed stock and option prices can be negative as shown by Aït-Sahalia and Lo (2000) and Jackwerth (2000). We rationalize this puzzle by a lack of conditioning on latent state variables. Once properly conditioned, risk aversion functions and pricing kernels are consistent with economic theory. A revisited version of this working paper was published in the April 2008 issue of the Review of Financial Studies.
Risk Management and Portfolio Construction in a Commodity Futures Programme
2007
This article focuses on risk management within the context of a total-return futures program centered on commodities. The following issues are addressed: the evaluation of normal versus eventful risk, the sizing of trades and strategy buckets, and the construction of a portfolio, which takes into consideration these risk and sizing metrics. The article provides examples from three historical portfolios in order to make this discussion concrete and practical.
Performance Measurement for Traditional Investment, Literature Survey
2007
This paper presents the state of the art of performance measurement in the area of traditional investment, from a simple evaluation of portfolio return to the more sophisticated techniques including risk in its various acceptations. It also describes models that take a step away from modern portfolio theory and allow a consideration of cases beyond mean-variance theory.
Asset-Liability Management Decisions In Private Banking
2007
Working from the observation that the contribution of asset-liability management techniques developed for institutional investors is not yet familiar within private banking, a new study from the EDHEC Risk and Asset Management Research Centre, entitled “Asset-Liability Management Decisions in Private Banking” shows the expected benefits of a transposition of that kind. According to the authors of the study, Noël Amenc, Lionel Martellini and Volker Ziemann, asset-liability management represents a genuine means of adding value to private banking that has not been sufficiently explored to date....
Response to CESR public consultation on Best Execution under MiFID - On the Importance of Transaction Cost Analysis
2007
Response to the CESR's public consultation on best execution under MiFID, EDHEC strongly defend the idea that the analysis of the total net proceeds of financial transactions represent the most important factor for assessing execution quality. But this analysis also represents the most significant conceptual and technical challenge the industry will face in order to consistently monitor execution quality, and therefore allow best execution to become a tangible and measurable objective for investment firms.
Quantification of Hedge Fund Default Risk
2007
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...
CP20: Significant improvements in the Solvency II framework but grave incoherencies remain - EDHEC response to Consultation Paper n° 20
2007
EDHEC position paper entitled "CP20: Significant improvements in the Solvency II framework but grave incoherencies remain", by Philippe Foulquier, Director of the EDHEC Financial Analysis and Accounting Research Centre, and Samuel Sender, Research Associate with the EDHEC Risk and Asset Management Research Centre, contains EDHEC's answer to CP20, a consultation process initiated by CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) on the "Advice to the European Commission in the Framework of the Solvency II Project on Pillar I Issues".
Transaction Cost Analysis in Europe: Current and Best Practices - European Survey
2007
A new report from EDHEC Risk Advisory, Transaction Cost Analysis in Europe: Current and Best Practices, which was commissioned by HSBC Investment Bank, reviews the conditions in which buy-side firms (traditional and alternative) are currently monitoring transaction costs and investigates the various issues related to transaction cost analysis in the context of the Markets in Financial Instruments Directive due to be enforced in November 2007. This directive contains an important provision related to Best Execution.
Extending Black-Litterman Analysis Beyond the Mean-Variance Framework
2007
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...
A Copula Approach to Value-at-Risk Estimation for Fixed-Income Portfolios
2007
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.
The Challenge of Hedge Fund Measurement: a Toolbox Rather Than a Pandora's Box
2006
This paper, which is being written to provide an overview of the multitude of publications we have seen on hedge fund performance, is the result of a reading and analysis of about 200 studies on this subject. The issue of performance measurement in the hedge fund industry has led to literature that is both abundant and controversial. The explanation of this complexity lies in the particular features of alternative funds.
QIS 2: Modelling that is at odds with the prudential objectives of Solvency II
2006
In a new position paper by Philippe Foulquier, director of the EDHEC Financial Analysis and Accounting Research Centre, and Samuel Sender, research associate with the EDHEC Risk and Asset Management Research Centre, entitled ‘QIS 2: Modelling that is at odds with the prudential objectives of Solvency II’, EDHEC regrets the approach chosen by the CEIOPS (Committee of European Insurance and Occupational Pensions Supervisors) for the European Commission as proposed in the QIS 2 (Quantitative Impact Study 2), which does not favour optimal management of the risks of European insurance companies....
The Impact Of IFRS And Solvency II On Asset-Liability Management And Asset Management In Insurance Companies
2006
A new study jointly produced by the EDHEC Risk and Asset Management Research Centre and the EDHEC Financial Analysis and Accounting Research Centre entitled ‘The Impact of IFRS and Solvency II on Asset-Liability Management and Asset Management in Insurance Companies’ reveals the contradictions inherent in the current Solvency II and IFRS provisions for insurance companies. The report shows notably that the numerous provisions proposed by the IFRS are at odds with the good risk management practices put forward by Solvency II. While IFRS and Solvency II should lead to a genuine evolution in the...
Assessing the Quality of Stock Market Indices: Requirements for Asset Allocation and Performance Measurement
2006
At a presentation to the members of the Af2i (French association of institutional investors) in Paris on September 12th, Noël Amenc, Director of the EDHEC Risk and Asset Management Research Centre, warned his institutional audience about the dangers of relying solely on stock market indices as a benchmark for their investment management performance.
Hedge Fund Returns: An Overview of Return-Based and Asset-Based Style Factors
2006
The goal of modelling is to find one or more factors that offer the best explanatory power for a given variable. Applied to hedge fund returns, it allows their sources to be better understood. In the search for significant factors, two approaches can be employed, namely return-based style factors (RBS factors) and asset-based-style factors (ABS factors).
Momentum Profits and Time-Varying Unsystematic Risk
2006
This article considers whether the widely documented momentum profits are a compensation for time-varying unsystematic risk as described by the family of autoregressive conditionally heteroscedastic models. The motivation for estimating a GJR-GARCH(1,1)-M model stems from the fact that, since losers have a higher probability than winners to disclose bad news, one cannot assume a symmetric response of volatility to good and bad news. A revisited version of this paper was published in the April 2008 issue of the Journal of Banking & Finance.
A Reply to the CESR Recommendations on the Eligibility of Hedge Fund Indices for Investment of UCITS
2006
In a document entitled ‘A Reply to the CESR Recommendations on the Eligibility of Hedge Fund Indices for Investments of UCITS’, Noël Amenc and Felix Goltz of the EDHEC Risk and Asset Management Research Centre have urged the CESR to reconsider their position on suspending the eligibility of hedge fund indices.
The Tortoise versus the Hare: The Role of Term Structure versus Spot Price Trends in Determining Commodity Futures Returns
2006
In the past, even if spot commodity prices declined, a commodity futures investor could still have a positive statistical expectation of profit, and that has been through the “roll yield” embedded in certain commodity futures contracts.When a near-month futures contract is trading at a premium to more distant contracts, we say that a commodity futures curve is in “backwardation.” Conversely, when a near-month contract is trading at a discount to more distant contracts, we say that the curve is in “contango.” When a commodity futures contract is in backwardation, an investor has two potential...
The Impact of Non-Normality Risks and Tactical Trading on Hedge Fund Alphas
2006
This paper highlights the importance of non-normality risks and tactical asset allocation in assessing hedge fund performance. As such, it underlines the inaccuracies of previous papers on hedge fund performance that ignored higher moments in the distribution of hedge fund returns and assumed constant asset allocation. Correcting for these shortcomings, the authors find that failure to account for non-normality risks and tactical asset allocation on average leads to an overstatement of performance by 1.54% and to incorrect statistical inference on the performance of 1 out of 4 funds. On...
How to Include Hedge Funds in a Risk Allocation Framework
2006
This article, which was originally written as a two-part series, discusses the innovative ways in which academics and practitioners are enhancing asset allocation methodologies in order to incorporate hedge funds. It begins by discussing the current practice in asset allocation work and goes on to describe the unique problems that occur when this methodology is applied to hedge funds. It also discusses a number of leading edge solutions to these problems. Included are anecdotes from anonymous hedge fund managers and traders, which illustrate some of the academic points made in the article. A...
Commodities at the Cross-Roads: Where to Now?
2006
While it is useful to review the past performance of commodities, investors are most concerned about what to expect going forward. And unfortunately, one cannot look in the rear-view mirror to see what is coming up ahead. In this article, the author reviews the drivers of commodity returns along with some observations on what the future may hold.
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About EDHEC
Operating from campuses in Lille, Nice, Paris, London and Singapore, EDHEC is one of the world’s top 15 business schools. Fully international and directly connected to the business world, EDHEC commands a strong reputation for research excellence and the ability to train entrepreneurs and managers capable of breaking new ground. EDHEC functions as a genuine laboratory of ideas and produces innovative solutions valued by businesses. The School’s teaching is inspired by its research work and a focus on “learning by doing”, all with the aim of equipping people with the skills to succeed in business.
