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Hedge Fund Return Predictability in the Presence of Model Risk

Argyropoulos, Christos and Panopoulou, Ekaterini and Nikolaos, Voukelatos and Zheng, Teng (2021) 'Hedge Fund Return Predictability in the Presence of Model Risk.' The European Journal of Finance. pp. 1-25. ISSN 1351-847X

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Hedge funds implement elaborate investment strategies that include a variety of positions and assets. As a result, there is significant time variation in the set of risk factors and their respective loadings which in turn introduces severe model risk in any attempt to model and forecast hedge fund returns. In this study, we investigate the statistical and economic value of incorporating heteroscedasticity, non-normality, time-varying parameters, model selection risk and parameter estimation risk jointly in hedge fund return forecasting and fund of funds construction. Parameter estimation risk is dealt with a time-varying parameter structure, while model selection uncertainty is mitigated by model averaging or model selection. We adopt a dynamic model averaging approach along with the conventional Bayesian averaging technique. Our empirical results suggest that accounting for model risk can significantly improve the forecasting accuracy of hedge fund returns and consequently the performance of funds of hedge funds.

Item Type: Article
Uncontrolled Keywords: Forecasting; Hedge funds; Dynamic model averaging; Model risk; Fund of funds
Divisions: Faculty of Social Sciences
Faculty of Social Sciences > Essex Business School
Faculty of Social Sciences > Essex Business School > Essex Finance Centre
SWORD Depositor: Elements
Depositing User: Elements
Date Deposited: 07 Jan 2022 16:50
Last Modified: 18 Aug 2022 12:23

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