Title: Measuring hedge fund performance: A Markov regime-switching with false discoveries approach
Authors: Gulten Mero - Universite de Cergy-Pontoise and THEMA (France) [presenting]
Abstract: A Markov regime-switching approach is proposed which accounts for false discoveries in order to measure hedge fund performance. It enables us to extract information from both time-series and cross-sectional dimensions of panels of individual hedge fund returns in order to distinguish between skilled, unskilled and zero-alpha funds for a given state of the economy. Applying our approach to individual hedge funds belonging to the Long/Short Equity Hedge strategy, we find that their performance cannot be explained by luck alone, and that the proportion of zero-alpha funds in the population decreases when accounting for alpha regime dependence. However, the proportion of truly skilled funds is higher during expansion periods, while unskilled funds tend to be more numerous during recession periods. Moreover, sorting on regime dependent instead of unconditional alphas improves investors' ability to select funds that outperform their benchmarks in both regimes of the economy by maximizing the performance persistence effect of top performer fund portfolios.