EDHEC Publications
Towards the Integration of Extreme Values in Obtaining the Value-at-Risk
2003
In this paper we aim to show how risk managers can benefit from this integration of EVT (Extreme Value Theory) into their VaR calculation and how they could easily reduce the effects of some of the important drawbacks that VaR presents.
Improving the Market Model: The 4-State Model Alternative
2003
The present paper conducts an empirical study by examining the Market Model and the three versions of the 4-State Model (translated, rotated and un-rotated) in a mean-beta framework. Using daily returns from the CAC 40 Index's assets, we find that the explanatory power of the 4- State Model is greater than the one of the Market Model and this effect is improved by rotation. A reduction in the non-systematic risk is also observed when switching from Market Model to 4- State Models. Surprisingly, the betas are more stable when using any version of the 4-State Model. This could have a strong...
Grafting Information in Scenario Trees Application to Option Prices
2003
Many mathematical models used in management science do not impose any complex restrictions on the parameter values arising in a given problem. As a consequence, when the instances arise from a specific real-world application, the models under consideration are usually sufficiently robust to remain meaningful even if their numerical parameters are not estimated with very high accuracy or, alternatively, if small perturbations are applied to the parameter values. Things can be quite different, however, with models developed for financial applications. Indeed, in such applications, many models...
On the Valuation and Incentive Effects of Executive Cash Bonus Contracts
2003
Executive compensation packages are often valued in an inconsistent manner: while employee stock options (ESOs) are typically valued ex-ante, i.e., before uncertainties are resolved, cash bonuses are valued ex-post, i.e., by discounting the realized cash grants. Such a lack of consistency can, potentially, distort empirical results. A related, yet mostly overlooked, problem is that when ex-post valuation is used pay-performance measures can not be well defined. Consistent use of ex-ante valuation for all components of a compensation package would simultaneously resolve both of these problems...
Tactical Asset Allocation
2003
Tactical Asset Allocation (TAA) broadly refers to active strategies that seek to enhance portfolio performance by opportunistically shifting the asset mix in a portfolio in response to the changing patterns of return and risk.
Portfolio optimisation and hedge fund style allocation decisions
2003
This paper attempts to evaluate the out-of-sample performance of an improved estimator of the covariance structure of hedge fund index returns, focusing on its use for optimal portfolio selection. A revisited version of this paper was published in the Fall 2002 issue of the Journal of Alternative Investments.
Four-State Model vs. Market Model: Part I
2002
The present paper conducts an empirical study by examining the Market Model and the three versions of the 4-State Model (translated, rotated and un-rotated) in a mean-beta framework. Using daily returns from the CAC 40 Index’s assets, we find that the explanatory power of the 4-State Model is greater than the one of the Market Model and this effect is improved by rotation. A reduction in the non-systematic risk is also observed when switching from Market Model to 4-State Models. Surprisingly, the betas are more stable when using any version of the 4-State Model.
Asset Allocation
2002
Two competing approaches are used in practice to build portfolios: bottom-up and topdown. The bottom-up approach is the older and the more traditional, and focuses on individual stock picking. The top-down approach gives more importance to the choice of different markets as opposed to individual security selection, and, as such emphasizes the importance of asset allocation.
The Brave New World of Hedge Fund Indices
2002
The fact that hedge funds have started to gain widespread acceptance while remaining a somewhat mysterious asset class enhances the need for better measurement and benchmarking of their performance. One serious problem is that existing hedge fund indices provide a somewhat confusing picture of the investment universe. In this paper, we first present detailed evidence of strong heterogeneity in the information conveyed by competing indices. We also attempt to provide remedies to the problem and suggest various methodologies designed to help build a “pure style index”, or “index of the indices...
Methodology Applied for the Agefi Asset Management Awards
2002
Fund performance measurement is an important issue both for professionals, for whom it is the justification of their remuneration, and for researchers, for whom the right evaluation of returns and risks constitutes the very core of modern portfolio theory. This twofold academic and professional issue underlies extensive research and numerous methods for evaluating the performance of funds. Indeed, the diversity of the resulting models and methods has consequences on fund performance rankings and the evaluation of fund performance. Identifying the best managers actually presupposes taking two...
Mean-Modified Value-at-Risk Optimization with Hedge Funds
2002
Based on the normal Value-at-Risk, we develop a new Value-at-Risk method called Modified Value-at-Risk. This Modified Value-at-Risk has the property to adjust the risk, measuring with the volatility only, with the skewness and the kurtosis of the distribution of returns. The Modified Value-at-Risk allows to measure first the risk of portfolio with assets non normally distributed like hedge funds or technology stocks and to compute optimal portfolio by minimizing the Modified Value-at-Risk at a given confidence level. A revisited version of this paper was published in the Autumn 2002 issue of...
Trend-following Hedge Funds and Multi-period Asset Allocation
2002
Selected hedge funds employ trend-following strategies in an attempt to achieve superior risk adjusted returns. The authors employ a lookback straddle approach for evaluating the return characteristics of a trend following strategy. The strategies can improve investor performance in the context of a multi-period dynamic portfolio model. The gains are achieved by taking advantage of the funds’ high level of volatility.
Evidence of Predictability in Hedge Fund Returns and Multi-Style Multi-Class Tactical Style Allocation Decisions
2002
While there has been a significant amount of research on the predictability of traditional asset classes, very little is known about the predictability of returns emanating from alternative vehicles such as hedge funds. This paper attempts to fill this gap by documenting evidence of predictability in hedge fund returns. A revisited version of this paper was published in the September/October 2003 issue of the Financial Analysts Journal.
The Difficulties of Measuring the Benefits of Hedge Funds
2002
In this paper, the use mean-variance approach for the determination of the benefits of allocations to hedge funds is critically evaluated. The advantages of investing in hedge funds are often explained and demonstrated with reference to a shift in the efficiency frontier of traditional portfolios. The added value of hedge funds is almost always indicated in a mean-standard deviation environment and should in our view be reconsidered. The estimated risk exposure can be quantified by the introduction of Value-at-risk analysis corrected according to higher moments of distribution. With this new...
Benefits and Risks of Alternative Investment Strategies
2002
The growth of alternative investment has been considerable in recent years. For both institutional and private investors, it seems that alternative investment now constitutes a distinct class within their overall asset allocation. A revisited version of this paper was published in the July 2003 issue of the Journal of Asset Management.
An Analysis of Hedge Fund Performance Using Loess Fit Regression
2002
In this article, we analyze the returns distribution of Hedge Funds strategies, the average returns obtained over the past ten years and their correlation with a traditional portfolio. The aim is to identify the characteristics of each Hedge Fund investment strategy in order to be able to construct an optimal Hedge Fund portfolio for a Swiss pension fund. We will show that the classical linear correlation and the classical linear regression cannot be applied for Hedge Funds. Moreover, we will show that only three strategies, Convertible Arbitrage, Market Neutral and CTA, give diversification...
Risk Management Lessons in Leveraged Commodity Futures Trading
2002
This paper discusses the practical issues involved in applying a disciplined risk management methodology to futures trading and shows how to apply methodologies derived from both conventional asset management and hedge fund management to futures trading. It also discusses some of the risk management issues, which are unique to leveraged futures trading.
An Integrated Framework for Style Analysis and Performance Measurement
2002
In this paper, we propose an integrated framework for assessing the risk-adjusted performance of mutual fund managers. The methodology is designed so as to be consistent not only with modern portfolio theory but also with constraints imposed by practical implementation in a context where the presence of a variety of investment styles needs to be accounted for. A revisited version of this paper was published in the Summer 2003 issue of the Journal of Performance Measurement.
The Cross-Section of Expected Stock Returns at the Paris Stock Exchange
2002
This study reconsiders the subject of describing the expected return of French stocks through different variables: the beta coefficient drawn from the CAPM, the market capitalisation and book-to-price ratio and the si and hi sensitivities to the SMB and HML return premiums taken from Fama and French's three-factor model.
Rebalancing Strategies for Long-Term Investors
2002
Leading pension plans employ asset and liability management systems for optimizing their strategic decisions. The multi-stage models link asset allocation decisions with payments to beneficiaries, changes to plan policies and related issues, in order to maximize the plan’s surplus within a given risk tolerance. Temporal aspects complicate the problem but give rise to special opportunities for dynamic investment strategies.Within these models, the portfolio must be re-revised in the face of transaction and market impact costs. The re-balancing problem is posed as a generalized network with...
It's Time for Asset Allocation
2001
Despite repeated evidence that asset allocation accounts for a very large fraction of a portfolio return, the industry has never stopped favouring stock picking as the preferred form of active investment strategy. In this paper, we attempt to rehabilitate the importance of active asset allocation in the investment process. A revisited version of this paper was published in the December 2001 issue of the Journal of Financial Transformation.
Measure for Measure
2001
In a previous paper, Life at Sharpe's End, the author touched upon the difficulty of using standard measures to evaluate a number of hedge fund strategies. In this article, after reviewing these difficulties, she discusses the state-of-the-art methodology in this area.
Life at Sharpe's End
2001
For futures programs, the meaning of rate-of-return numbers can be somewhat ambiguous, given that one does not need to set aside capital in the amount of a program’s funding level. Instead, an investor can fractionally fund an account using “notional funding.”
Derivatives in Portfolio Management: Why Beating the Market is Easy
2000
Under the efficient market hypothesis, overwriting calls or purchasing insurance should not improve risk-adjusted portfolio returns. A proper analysis should show that if options are traded at a fair cost, the risk-reward characteristics of an option position would fall on the efficient market line. In this paper we show that, due to several limitations of mean-variance analysis, this is not the case in practice. We quantify and identify the nature of the resulting biases for performance evaluation, and explain why alternative measures such as semi variance do not help in avoiding such biases...
Commodity Scarcity and the GSCI Futures Curve
2000
This article will argue that long-only investments in the commodity futures markets, specifically those represented by the GSCI, are only advisable under a well-defined circumstance. One needs to use a reliable indicator of scarcity before investing in commodities in order to be assured of earning positive returns. This indicator also assists a commodity investor in avoiding huge losses that can result from investing in commodities during times of surplus. We will describe this indicator and note empirical and theoretical evidence for its use.
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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.
