Hedge Funds

List of Tables xi List of Figures xvii List of Color Plates xxi Acknowledgments xxiii Chapter 1: Introduction 1 1.1 Tail Risk 7 1.2 Nonlinear Risks 13 1.3 Illiquidity and Serial Correlation 25 1.4 Literature Review 30 Chapter 2: Basic Properties of Hedge Fund Returns 34 2.1 CS/Tremont Indexes 37 2.2 Lipper TASS Data 40 2.3 Attrition Rates 43 Chapter 3: Serial Correlation, Smoothed Returns, and Illiquidity 64 3.1 An Econometric Model of Smoothed Returns 66 3.2 Implications for Performance Statistics 70 3.3 Estimation of Smoothing Profiles 75 3.4 Smoothing-Adjusted Sharpe Ratios 79 3.5 Empirical Analysis of Smoothing and Illiquidity 83 Chapter 4: Optimal Liquidity 97 4.1 Liquidity Metrics 98 4.2 Liquidity-Optimized Portfolios 105 4.3 Empirical Examples 107 4.4 Summary and Extensions 117 Chapter 5: Hedge Fund Beta Replication 121 5.1 Literature Review 123 5.2 Two Examples 124 5.3 Linear Regression Analysis 126 5.4 Linear Clones 138 5.5 Summary and Extensions 164 Chapter 6: A New Measure of Active Investment Management 168 6.1 Literature Review 170 6.2 The AP Decomposition 172 6.3 Some Analytical Examples 181 6.4 Implementing the AP Decomposition 186 6.5 An Empirical Application 193 6.6 Summary and Extensions 197 Chapter 7: Hedge Funds and Systemic Risk 198 7.1 Measuring Illiquidity Risk 200 7.2 Hedge Fund Liquidations 203 7.3 Regime-Switching Models 211 7.4 The Current Outlook 215 Chapter 8: An Integrated Hedge Fund Investment Process 217 8.1 Define Asset Classes by Strategy 221 8.2 Set Portfolio Target Expected Returns 222 8.3 Set Asset-Class Target Expected Returns and Risks 222 8.4 Estimate Asset-Class Covariance Matrix 223 8.5 Compute Minimum-Variance Asset Allocations 224 8.6 Determine Manager Allocations within Each Asset Class 225 8.7 Monitor Performance and Risk Budgets 227 8.8 The Final Specification 227 8.9 Risk Limits and Risk Capital 229 8.10 Summary and Extensions 235 Chapter 9: Practical Considerations 237 9.1 Risk Management as a Source

Andrew W. Lo is the Harris & Harris Group Professor at the MIT Sloan School of Management, and director of the MIT Laboratory for Financial Engineering. He is the coauthor of A Non-Random Walk Down Wall Street and The Econometrics of Financial Markets (both Princeton).

"Andrew Lo is a major figure in finance so his new book on the fast-moving world of hedge funds ought to be in the 'must read' category. . . . The book is the authoritative distillation into an accessible form of a huge amount of academic research and practical experience. . . . Professor Lo gives a masterful illustration of the problems in gauging hedge fund performance with his famous fantasy fund Capital Decimation Partners."--Steven Bell, The Business Economist