The Dangers of Historical Hedge Fund Data
by Andrew B. Weisman & Jerome D. Abernathy
July 2003

Abstract
Risk budgeting provides an excellent framework for combining the competing
interests of mean-variance efficiency and the precise liability constraints faced by
an institutional investor. Such a framework is not however directly applicable to
certain classes of investments, most notably hedge funds. The risk budgeting
process typically requires the development of statistically derived
characterizations of targeted investments...

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The Dangers of Mechanical Investment Decision-Making: The Case of Hedge Funds
by Harry M. Kat
November 28, 2003

Abstract
Over the last 20 years, investors have come to approach investment decision-making in an increasingly mechanical manner. Optimisers are filled up with historical return data and the ‚optimal™ portfolio follows almost automatically. In this paper we argue that such an approach can be extremely dangerous, especially when alternative investments such as hedge funds are involved...

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Dealers’ Hedging of Interest Rate Options in the U.S. Dollar Fixed-Income Market
by John E. Kambhu
Stern School of Business, New York University & Stanford University

Abstract
As derivatives markets have grown, the scope of financial intermediation has evolved beyond credit intermediation to cover a wide variety of risks. Financial
derivatives allow dealers to intermediate the risk management needs of their customers by unbundling customer exposures and reallocating them through the derivatives markets. In this way, a customer’s unwanted risks can be traded away or hedged, while other exposures are retained...

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Debt Crises and the Development of International Capital Markets
by Andrea Pescatori & Amadou N.R. Sy

Abstract
Crises on external sovereign debt are typically defined as defaults. Such a definition accurately captures debt-servicing difficulties in the 1980s, a period of numerous defaults on bank loans. However, defining defaults as debt crises is problematic for the 1990s, when sovereign bond markets emerged...

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A Decomposition of Stock Index Futures Mispricing and the Price Effects of Index Arbitrage
by Andrew West
February, 2003

Abstract
This paper uses a vector autoregressive system of equations to model the dynamic interactions between an equities index, stock index futures contract and mispricing series. It is suggested that stock index futures mispricing is a result of inefficiencies in both the equity market and the futures market. This is confirmed by a decomposition of the mispricing series, which demonstrates that information arriving in the futures market, proxied by a permanent unexpected change in the futures price, is only partially impounded by the index and only with a protracted lag...

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Defaults & Returns on High Yield Bonds: Analysis Through 2001
by Edward I. Altman and Pablo Arman

Abstract
The year 2001 was remarkable on many fronts.For the high yield market, it was a year of crushing record numbers of defaults and distressed exchanges, combined with predictable low recovery rates. Despite these fundamental problems and the “flight to quality” following the terrorist attacks in September, the high yield market displayed impressive resiliency...

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The Default Risk of High-Yield Bonds
by Cynthia G. McDonald & Linda M. Van De Gucht
University of Missouri at Columbia & Katholieke Universiteit Leuven
July, 1996

Abstract
This paper investigates the default behavior of original issue rated non-convertible high-yield bonds. Previous studies of high-yield bond defaults provide evidence of an aging effect: the longer bonds have been outstanding, the greater the default probability. However, Blume, Keim and Patel (1991) assert that this aging relationship reflects changing economic conditions...

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Derivation of the Mean-Gini Efficient Portfolio Frontier
by Haim Shalit & Shlomo Yitzhaki
Ben-Gurion University of the Negev and Hebrew University of Jerusalem
October 3, 2002

Abstract
One main advantage of the mean-variance (MV) portfolio frontier is its simplicity and ease of derivation. Its major shortcoming lies in its familiar restrictions, such as the quadraticity of preferences or the normality of distributions. We derive the mean-Gini (MG) efficient portfolio frontier as a workable alternative to MV. If asset distributions are restricted, the MG frontier derivation is identical in structure to the MV-efficient frontier derivation. The price paid for this simplicity is that some information about the distribution of assets gets lost. We numerically derive MG and mean-extended Gini (MEG) efficient frontiers and compare the results to the MV frontier. MEG allows for the explicit introduction of risk aversion in building the efficient frontier. For U.S. classes of assets, MG and MEG efficient portfolios constructed using Ibbotson monthly returns appear to be more diversified than MV portfolios. When short sales are allowed, distinct investor risk aversions lead to different patters of portfolio diversification, a result that is less obvious when short sales are forecasted.

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Detecting Changes of the Efficient Frontier Allocation in an Elliptical Model
by Taras Bodnar & Wolfgang Schmid
Department of Statistics, European University Viadrina

Abstract
In this paper we derive the econometrical background for detecting structural changes in the efficient frontier allocation assuming asset returns to be matrix elliptically contoured distributed. This is done in both cases: with or without a riskless rate. Our results generalize the findings of Bodnar and Schmid (2004b), who considered the distributional properties of the efficient frontier estimator and presented the test for the mean-variance efficiency in the normal case...

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Detecting Switching Strategies in Equity Hedge Funds
by Carol Alexander & Anca Dimitriu
ISMA Centre, University of Reading
April, 2005

Abstract
Equity hedge funds are thought to effectively operate market timing by implementing switching strategies conditional on market circumstances. In this paper we use only the reported monthly returns on a set of funds to infer the type of switching strategies they follow, if any, as well as their switching times. A set of regime-switching models for each equity hedge funds' returns against various benchmarks are estimated; subsequently we answer the following general questions: What proportion of equity funds seem to have switching strategies in place?...

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Determinants and Implications of Arbitrage Holdings in Acquisitions
by Jim Hsieh & Ralph A. Walkling
Ohio State University
June, 1999

Abstract
This study investigates arbitrage activities and their impact on acquisitions. The literature contains arguments for both passive and active roles of arbitrageurs during the takeover process. Larcker and Lys (1987) suggest that arbitrageurs are passive, having superior ability to predict offer success...

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Deviation Measures in Generalized Linear Regression
by R. Tyrrell Rockafellar, Stanislav Uryasev, & Michael Zabarankin
University of Florida, Gainesville
December 21, 2002

Abstract
Linear regression is traditionally based on the minimization of variance, or equivalently, standard deviation, but other approaches are possible in which standard deviation is replaced by something more general. A one-to-one correspondence is now known between risk measures, such as have been introduced for various applications in finance, and a large class of deviation measures characterized by simple axioms. Included in that class are asymmetric measures coming from conditional value-at-risk and other currently attractive notions. This paper looks at deviation in that wide sense, formulating the associated problem of regression and investigating the existence and uniqueness of the coefficients that constitute a solution. Such coefficients are characterized in ways that provide a key to their computation.

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Differentiability of the Efficient Frontier when Commitment to Risk Sharing is Limited
by Thorsten V. Koeppl
European Central Bank
February, 2003

Abstract
This paper shows that the value function describing efficient risk sharing with
limited commitment is not necessarily differentiable everywhere. We demonstrate
that as a consequence it can be efficient for consumption in the long-run to be
independent of lagged income even if limited commitment prevents first-best risk
sharing. Provided agents are symmetric this result is linked to the differentiability
of the efficient frontier at the point where all agents are promised the same level of utility...

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Direct Tests of Index Arbitrage Models
by Robert Neal
Kelley School of Business, Indiana University
December, 1996

Abstract
Previous tests of stock index arbitrage models have rejected the no-arbitrage constraint imposed by these models. This paper provides a detailed analysis of actual S&P 500 arbitrage trades and directly relates these trades to the predictions of index arbitrage models. An analysis of arbitrage trades suggests that i) short-sale rules are unlikely to affect the cash-futures mispricing, ii) the opportunity cost of arbitrage funds exceeds the Treasury bill rate, and iii) the average price discrepancy captured by arbitrage trades is small...

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Distressed Debt-Investing in Deutschland
by Christoph Schalast and Christian Daynes
HfB Business School of Finance & Management
September, 2005

Abstract
The global distressed debt market has been established for some years now, however within this investment universe German Distressed Debt is generally considered as underdeveloped. The aim of this paper is to highlight why Investments are transacted and the framework of processes involved within the German market additionally; the paper focuses on current active investors and concludes with a market survey covering the impressions of these participants.

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Diversification Benefits and Persistence of U.S.-Based Global Bond Funds
by Sirapat Polwitoon & Oranee Tawatnuntachai
Sigmund Weis School of Business & School of Business Administration - Penn State
May, 2005

Abstract
This paper examines diversification benefits and performance persistence of 188 U.S.-based global bond funds that survived and were defunct during the period of 1993 to 2004. Consistent with managed fund literature, global funds underperform broad-based benchmark indexes; however, the underperformance is less than the funds’ expense ratio. The results using both simple and time-varying frameworks suggest that global funds provide higher total return and comparable risk-adjusted return to domestic bond funds...

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Diversification into the Entire Economy: The Moral Imperative of the Super Efficient Portfolio on the Efficient Frontier
by Herbert A. Whitehouse
Whitehouse Law Firm

Abstract
In these troubled economic times, state pension funds are struggling to make ends meet. In the following essay, the author contemplates a developing and increasingly realistic scenario involving diversification of pension monies, especially state pension fund monies, into the entire economy. Commercial banks are seen as central to this move toward investment prudence...

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Diversification and Persistence in Hedge Funds
by Craig W. French, Damian B. Ko, & David Abuaf
Corbin Capital Partners, L.P.
October 31, 2005

Abstract
We examine the current fund of hedge funds universe, and find that funds of hedge funds report holding between 1 and 200 underlying funds, and generally hold 10-30, with close to 20 on average. We regress the performance of this universe on the number of holdings and find that return is practically orthogonal to the number of underlying hedge funds held. However, when we regress risk-adjusted return measured by the ex post Sharpe ratios of funds-of-hedge funds, we do find a statistically significant positive relation over 5-year periods; this seems consistent with our findings that diversification reduces volatility...

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The Diversification Properties of Hedge Fund Investments
by Eckhard Freimann
Imperial College, London

Abstract
This study analyses the trade off between manager specific and systematic risk of portfolio of hedge funds. We compare the properties of naively constructed portfolios with those of fund of hedge funds, in order to assess the added value of the hedge fund managers. The results suggest that the hedge fund investor is confronted with the dilemma of having either a concentrated portfolio with a high volatility but a low systematic risk or holding a well diversified portfolio with a low volatility but a high systematic risk...

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Diversification and Yield Enhancement with Hedge Funds
by Gaurav S. Amin & Harry M. Kat
Schroder Hedge Funds, London & Cass Business School - City University, London
October 7, 2002

Abstract
In this paper we study the diversification effects from introducing hedge funds into a traditional portfolio of stocks and bonds. We find that 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 is less straightforward than often suggested and includes a definite trade-off between profit and loss potential...

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Diversifying among Hedge Fund Strategies: An Alternative Frontier
by Emily Perskie
Duke University
Spring 2003

Abstract
The goal of this study is to create optimal portfolios of hedge funds. This paper discusses the different investment styles within the hedge fund universe along with their specific risk, return, and correlation characteristics. Markowitz’s portfolio selection model is used to create an efficient frontier to determine the best way for an investor to allocate capital among hedge fund strategies...

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Diversifying Market Risk through Market-Neutral Strategies
by Marco A. Navone
Financial Markets & Institutions Department - Bocconi University
September 19, 2001

Abstract
Usually hedge funds are linked to concepts such "superior selection ability" and "abnormal returns" (subject to abnormal risks). Recent literature has pointed out that seldom hedge funds achieve performances significantly higher than broad capitalization market indices or mutual funds, and that basically hedge funds are just a different way to rule the agency relation between investors and the investment manager. From this consideration follows that one of the most important features of hedge funds is the manager's ability to take both long and short positions on the markets...

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Do Banks Strategically Time Public Bond Issuance to Manipulate the Accompanying Disclosure, Due Diligence, and Investor Scrutiny?
by Daniel M. Covitz & Paul Harrison
Federal Reserve Board
April, 2002

Abstract
This paper tests and finds evidence for a new hypothesis that bank managers time their firm’s public bond issuance in order to manipulate the accompanying disclosure, due diligence and investor scrutiny. The main testable implication of this hypothesis is that the observable credit quality of a bank should improve around or after bond issuance. We test this and other implications of the hypothesis, controlling for alternative explanations, using a data set that combines ratings migrations, equity returns, bond issuance, and balance sheet data for US bank holding companies...

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Does Alpha Really Matter? Evidence from Mutual Fund Incubation, Termination and Manager Change
by Richard B. Evans
January 2004

Abstract
The assumption that market participants risk-adjust when measuring performance is common in finance. However, empirical research has shown that raw returns play an important role in retail investment decisions. As financially sophisticated investors, fund management companies understand the importance of risk-adjustment, but be-cause their profits depend on retail investment, raw returns may influence company strategy...

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Does Foreign Ownership Contribute to Sounder Banks in Emerging Markets? The Latin American Experience
by Jennifer S. Crystal, B. Gerard Dages, & Linda S. Goldberg
by Federal Reserve Bank of New York
May 29, 2001

Abstract
Foreign bank entrants into emerging markets are usually thought to improve the condition and performance of acquired institutions, and more generally to enhance local financial stability. We use bank-specific data for a range of Latin American countries since the mid-1990s to address elements of this claim. Across the seven largest countries, we find that the financial strength ratings of local banks acquired by foreign entities generally show a slight improvement relative to their domestic counterparts...

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Does the Use of Financial Derivatives Affect Earnings Management Decisions?
by Jan Barton
Goizueta Business School - Emory University
January 22, 2000

Abstract
I examine the effects of derivatives use on earnings management behavior. I develop a self-selection simultaneous-equations model that captures managers' incentives to use derivatives and manage discretionary accruals. Empirical results from estimating the model on 1994-1996 data for a sample of 304 Fortune 500 firms indicate that firms with larger derivatives portfolios have lower levels of
discretionary accruals...

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Do fixed income securities also show asymmetric effects in conditional second moments?
by Lorenzo Cappiello

Abstract
The so-called “asymmetric volatility” phenomenon is one of the empirical regularities shown by (conditional) estimates of equity second moments. Typically, volatility increases more after negative than positive return shocks of the same magnitude, and, sometimes, it even falls subsequent to an increase in stock prices. Two explanations have been put forth for this phenomenon: The leverage effect hypothesis, due to Black (1976) and Christie (1982), and the volatility feedback effect proposed by Campbell and Hentschell (1992) and extended by Wu (2000). Surprisingly, whereas there has been a proliferation of conditional econometric models able to capture asymmetry in volatility (see Hentscell, 1995, for a synthesis), there is a lack of conditional econometric specifications able to explicitly model asymmetry in covariances.

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Do Hedge Funds Have Enough Capital? A Value-at-Risk Approach
by Anurag Gupta & Bing Liang
February, 2003

Abstract
In this paper, we examine the risk characteristics and capital adequacy of hedge funds using Value-at-Risk (based on Extreme Value Theory) as the criterion for measuring risk and estimating capital requirements. Using extensive data on nearly thirteen hundred live and dead hedge funds, we find that the vast majority
of funds are adequately capitalized. In addition, a large fraction of hedge funds maintain risk profiles comparable to that of an equivalent investment in a broad equity market index (like the S&P 500). From the perspective of capital adequacy concerns, our results lend support to the arguments against stricter regulation and oversight of the hedge fund industry, in contrast to some regulators’ desire and inclination towards increased regulation.

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Do Market Intermediaries Hedge their Risk Exposure with Derivatives? Evidence from UK Govt. Bond Dealers’ Spot & Derivatives Positions
by Narayan Y. Naik and Pradeep K. Yadav
February, 2000

Abstract
Using a comprehensive dataset from the Bank of England of UK government bond dealers’ spot and derivatives positions at the end of each day, we find that dealers actively hedge their spot risk with derivatives. However, they hedge selectively rather than engage in full cover hedging. Some of these dealers hedge not only their main risk factor, i.e., Duration exposure, but also the second risk factor, Twist exposure...

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Do Market Timing Hedge Funds Time the Market?
by Bing Liang & Yong Chen
February, 2005

Abstract
This paper examines whether market timing hedge funds, the self-claimed market timers, have the ability to time the market in the dimension of both return and volatility. Based on the market timing models of Treynor-Mazuy (1966), Henriksson-Merton (1981), and Busse (1999), we incorporate public information, derivative trading, and illiquid holding in our tests in order to capture the dynamic trading behavior of hedge fund managers. More importantly, we develop a new market timing model to test return timing and volatility timing jointly. This new model relates hedge fund returns to the squared Sharpe ratio of the market portfolio. With a sample of 157 market timing funds from TASS, HFR and TUNA databases, we find strong evidence of both return timing and volatility timing during the period 1990-2003. In particular, market timing exists mainly in bear market states. Cross-sectional analysis indicates that timing ability is related to some fund characteristics. Our results are confirmed by various robustness tests including bootstrap analysis.

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Do short sellers target firms with poor earnings quality? Evidence from earnings restatements
by Hemang Desai, Srinivasan Krishnamurthy, & Kumar Venkataraman
Cox School of Business & SUNY - Binghampton University
July 19, 2005


Abstract
We study the behavior of short sellers around earnings restatements. We find that short sellers start accumulating positions in the restatements firms several months in advance of the restatement announcement and subsequently unwind these positions after the drop in share price induced by the restatement. The increase in short interest is larger for firms with high levels of accruals prior to the restatement, and the association between short interest and accruals is robust to controlling for firm size, book-to-market ratio and residual standard deviation...

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A Double Sharpe Ratio
by Hrishikesh D. Vinod & Matthew R. Morey
Fordham University & Pace University
June 1, 1999

Abstract
Sharpe's (1966) portfolio performance ratio, the ratio of the portfolio's expected return to its standard deviation, is a very well known tool for comparing portfolios. However, due to the presence of random denominators in the definition of the ratio, the sampling distribution of the Sharpe ratio is somewhat difficult to determine. This paper studies the properties of Sharpe ratio and then uses the bootstrap methodology to suggest a new "double" Sharpe ratio which incorporates estimation risk...

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Downside Risk Metrics applied to Hedge Funds: An overview and some extensions
by Josep Perello
University of Barcelona

Abstract
Hedge Funds are considered as one of the portfolio management sectors which
shows a fastest growing for the past few years. These funds have been in
existence for several decades but they do not have become popular until the
1990’s. It is said that Hedge Funds are capable of making huge profits but
sometimes we get some news announcing that a certain Hedge Fund suffered
spectacular losses, not very often as someone might say...

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Dry Markets and Statistical Arbitrage Bounds for European Derivatives
by Joao Amaro de Matos & Ana Lacerda
2006

Abstract
We derive statistical arbitrage bounds for the buying and selling price of European derivatives under incomplete markets. In this paper, incompleteness is generated due to the fact that the market is dry, i.e., the underlying asset cannot be transacted at certain points in time. In particular, we refine the notion of statistical arbitrage in order to extend the procedure for the case where dryness is random, i.e., at each point in time the asset can be transacted with a given probability...

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The Due Diligence Defense Under Section 11 of the Securities Act of 1933
by William K. Sjostrom, Jr.
November 17, 2005

Abstract
Section 11 of the Securities Act of 1933 imposes civil liability for misstatements or omissions of material facts in a securities offering registration statement. Potential section 11 defendants include the issuer, directors, underwriters and accountants. Although section 11 was designed to have an in terrorem effect on these parties, section 11 liability is not absolute...

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Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models
by Robert Engle
New York University - Department of Finance
July, 2002

Abstract
Time varying correlations are often estimated with multivariate generalized autoregressive conditional heteroskedasticity (GARCH) models that are linear in squares and cross products of the data. A new class of multivariate models called dynamic conditional correlation models is proposed. These have the flexibility of univariate GARCH models coupled with parsimonious parametric models for the
correlations...

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Dynamic Investment Strategies: Portfolio Insurance Versus Efficient Frontier
by Sergei Esipov & Igor Vaysburd
Centre Solutions & Martingale Technologies, Inc.

Abstract
Selected dynamic investment strategies are analyzed within a unifying theoretical
framework. We suggest a Kolmogorov-type partial differential equation for a profit and loss (P&L) distribution of strategies contingent on the current value of the basic asset as well as on a balance of a trading account –“P&L-to-date”. This gives a possibility to study much wider class of strategies than is usually done in the literature and practical applications...

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Dynamic models for fixed-income portfolio management under uncertainty
by Stavros A. Zenios, Martin R. Holmer, Raymond McKendall, Christiana Vassiadou-Zeniou
University of Cyprus
March 15, 1999

Abstract
We develop multi-period dynamic models for fixed-income portfolio management under uncertainty, using multi-stage stochastic programming with recourse. The models integrate the prescriptive stochastic programs with descriptive Monte Carlo simulation models of the term structure of interest rates.
Extensive validation experiments are carried out to establish the effectiveness of the models in hedging against uncertainty, and to assess their performance vis-a`-vis single-period models...

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