Hedge Fund Predictability Under the Magnifying Glass:The Economic Value of Forecasting Individual Fund Returns, Doron Avramovy, Laurent Barrasz, and Robert Kosowskix, July 27, 2010
by Ryan Renicker
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The recent financial crisis has highlighted the need to search for suitable models forecasting hedge fund performance....
The recent financial crisis has highlighted the need to search for suitable models forecasting hedge fund performance.
This paper develops and applies a framework in which to assess return predictability on a fund-by-fund basis.
Using a comprehensive sample of hedge funds during the 994-2008 period, we identify the fraction of funds in each style that are truly predictable, positively or negatively, by macro variables.
Out-of-sample, exploiting predictability can be di¢ cult as estimation risk and model uncertainty lead to imprecise fund forecast.
Moreover, in our multi-fund setting, investors face a trade-o¤ between unconditional and predictable performance, as strongly predictable funds may exhibit low unconditional mean.
Nevertheless, a strategy that combines forecasts across predictors circumvents all these challenges and delivers superior performance.
We highlight the statistical and economic drivers of this performance, especially in periods when predictor values strongly depart from their long run means.
Finally, we use one such period, the 2008 crisis, as a natural out-of-sample experiment to validate the robustness of our findings.
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