Adapting pricing models to the non-linearity of hedge fund returns
In the sixth of a series of articles on hedge fund performance measurement, Edhec looks at conditional approaches that account for the non-linearity of hedge fund returns and the use of a modified version of the standard Capital Asset Pricing Model (CAPM) to consider the impact of higher moments on excess returns
In opposing static models, some authors consider the following issue to be important: static asset pricing models imply that risk and performance are constant over time. Due to investment decisions based on public information and dynamic trading strategies, in the case of hedge funds, static models present the risk of being mis-specified. If the risk profile is modified over the calculation period, it can have a strong impact on abnormal performance. This assumption goes against several studies
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