Financial Decisions - Document Index

Modeling Hedge Fund Returns

Nandita Das, Richard J. Kish, and David L. Muething^*

^*Wilkes University, Lehigh University and

Buckley Muething Capital Management Co., respectively

Abstract

Since hedge funds trade in many of the same types of asset classes that mutual funds trade, they should respond to similar external forces as proxied by a set of macroeconomic variables. Thus, our analytical modeling of hedge fund returns is undertaken using macroeconomic factors to test for the commonality of factors with the mutual fund industry. The analysis is carried out using both OLS and WLS estimation procedures, but caution must be applied when interpreting the OLS results because of presence of heteroscedasticity in the cross-sectional data. The results of the macroeconomic model lead to the conclusion that the macroeconomic variables default premium and term-premium explain hedge fund return in general. This lends support to the similarity hypothesis that the macroeconomic factors that explain equity return also have explanatory power for hedge fund returns.