Andrea Buraschi, Robert Kosowski, Worrawat Sritrakul
type="main"> Hedge fund managers are subject to several nonlinear incentives: performance fee options (call); equity investors' redemption options (put); and prime broker contracts allowing for forced deleverage (put). The interaction of these option-like incentives affects optimal leverage ex ante, depending on the distance of fund-value from the high-water mark. We study how these endogenous effects influence performance measures used in the literature. We show that reduced-form measures that do not account for these features are subject to economically significant false discovery biases. The result is stronger for low-quality funds. We propose an alternative structural methodology for conducting performance attribution in hedge funds.
{"title":"Incentives and Endogenous Risk Taking: A Structural View of Hedge Funds Alphas","authors":"Andrea Buraschi, Robert Kosowski, Worrawat Sritrakul","doi":"10.2139/ssrn.1785995","DOIUrl":"https://doi.org/10.2139/ssrn.1785995","url":null,"abstract":"type=\"main\"> Hedge fund managers are subject to several nonlinear incentives: performance fee options (call); equity investors' redemption options (put); and prime broker contracts allowing for forced deleverage (put). The interaction of these option-like incentives affects optimal leverage ex ante, depending on the distance of fund-value from the high-water mark. We study how these endogenous effects influence performance measures used in the literature. We show that reduced-form measures that do not account for these features are subject to economically significant false discovery biases. The result is stronger for low-quality funds. We propose an alternative structural methodology for conducting performance attribution in hedge funds.","PeriodicalId":185983,"journal":{"name":"Portfolio Choice","volume":"50 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2013-05-25","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"127949674","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Despite much work on hedging in incomplete markets, the literature still lacks tractable dynamic hedges in plausible environments. In this article, we provide a simple solution to this problem in a general incomplete-market economy in which a hedger, guided by the traditional minimum-variance criterion, aims at reducing the risk of a non-tradable asset or a contingent claim. We derive fully analytical optimal hedges and demonstrate that they can easily be computed in various stochastic environments. Our dynamic hedges preserve the simple structure of complete-market perfect hedges and are in terms of generalized "Greeks," familiar in risk management applications, as well as retaining the intuitive features of their static counterparts. We obtain our time-consistent hedges by dynamic programming, while the extant literature characterizes either static or myopic hedges, or dynamic ones that minimize the variance criterion at an initial date and from which the hedger may deviate unless she can pre-commit to follow them. We apply our results to the discrete hedging problem of derivatives when trading occurs infrequently. We determine the corresponding optimal hedge and replicating portfolio value, and show that they have structure similar to their complete-market counterparts and reduce to generalized Black-Scholes expressions when specialized to the Black-Scholes setting. We also generalize our results to richer settings to study dynamic hedging with Poisson jumps, stochastic correlation and portfolio management with benchmarking.
{"title":"Dynamic Hedging in Incomplete Markets: A Simple Solution","authors":"Suleyman Basak, G. Chabakauri","doi":"10.2139/ssrn.1297182","DOIUrl":"https://doi.org/10.2139/ssrn.1297182","url":null,"abstract":"Despite much work on hedging in incomplete markets, the literature still lacks tractable dynamic hedges in plausible environments. In this article, we provide a simple solution to this problem in a general incomplete-market economy in which a hedger, guided by the traditional minimum-variance criterion, aims at reducing the risk of a non-tradable asset or a contingent claim. We derive fully analytical optimal hedges and demonstrate that they can easily be computed in various stochastic environments. Our dynamic hedges preserve the simple structure of complete-market perfect hedges and are in terms of generalized \"Greeks,\" familiar in risk management applications, as well as retaining the intuitive features of their static counterparts. We obtain our time-consistent hedges by dynamic programming, while the extant literature characterizes either static or myopic hedges, or dynamic ones that minimize the variance criterion at an initial date and from which the hedger may deviate unless she can pre-commit to follow them. We apply our results to the discrete hedging problem of derivatives when trading occurs infrequently. We determine the corresponding optimal hedge and replicating portfolio value, and show that they have structure similar to their complete-market counterparts and reduce to generalized Black-Scholes expressions when specialized to the Black-Scholes setting. We also generalize our results to richer settings to study dynamic hedging with Poisson jumps, stochastic correlation and portfolio management with benchmarking.","PeriodicalId":185983,"journal":{"name":"Portfolio Choice","volume":"3 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2011-05-01","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128018370","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
Empirical Studies of household portfolios have shown that young and relatively poor households hold under-diversified portfolios that are concentrated in a small number of assets, a fact often attributed to various behavioral biases. We present a model in which relatively poor investors, i.e., investors with a little financial wealth, who receives labor income and have access to multiple risky assets rationally limit the number assets they invest in when faced with financial constraints such as margin requirements and restrictions on borrowing. We provide both theoretical and numerical support for our results and show, in an example calibrated to returns of five industry portfolios from 1927-2004, that while older investors optimally hold diversified portfolios, younger investors prefer portfolios that are concentrated in high-tech stocks that offer higher expected returns. Our results suggest that the ratio of financial wealth to labor income would be a useful control variable in household portfolio studies.
{"title":"Asset Selection and Under-Diversification with Financial Constraints and Income: Implications for Household Portfolio Studies","authors":"Hervé Roche, S. Tompaidis, Chunyu Yang","doi":"10.2139/ssrn.1363910","DOIUrl":"https://doi.org/10.2139/ssrn.1363910","url":null,"abstract":"Empirical Studies of household portfolios have shown that young and relatively poor households hold under-diversified portfolios that are concentrated in a small number of assets, a fact often attributed to various behavioral biases. We present a model in which relatively poor investors, i.e., investors with a little financial wealth, who receives labor income and have access to multiple risky assets rationally limit the number assets they invest in when faced with financial constraints such as margin requirements and restrictions on borrowing. We provide both theoretical and numerical support for our results and show, in an example calibrated to returns of five industry portfolios from 1927-2004, that while older investors optimally hold diversified portfolios, younger investors prefer portfolios that are concentrated in high-tech stocks that offer higher expected returns. Our results suggest that the ratio of financial wealth to labor income would be a useful control variable in household portfolio studies.","PeriodicalId":185983,"journal":{"name":"Portfolio Choice","volume":"40 1","pages":"0"},"PeriodicalIF":0.0,"publicationDate":"2009-03-18","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"","citationCount":null,"resultStr":null,"platform":"Semanticscholar","paperid":"128708877","PeriodicalName":null,"FirstCategoryId":null,"ListUrlMain":null,"RegionNum":0,"RegionCategory":"","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":"","EPubDate":null,"PubModel":null,"JCR":null,"JCRName":null,"Score":null,"Total":0}
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