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Cumulant instrument estimators for hedge fund return models with errors in variables

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We revisit the factors incorporated in asset pricing models following the recent developments in financial markets – i.e., the rise of shadow banking and the change in the transmission channel of monetary policy. We propose two versions of the Fung and Hsieh (2004) hedge fund return model, especially an augmented market model which accounts for the new dynamics of financial markets and the procyclicality of hedge fund returns. We run these models with an innovative Hausman procedure, tackling the measurement errors embedded in the models factor loadings. Our empirical method also allows for confronting the drawbacks of the instruments used to estimate hedge fund asset pricing models.

Keywords: C13; C19; C58; G12; G23; GMM; Hausman tests; asset pricing models; cumulant instruments; hedge funds

Document Type: Research Article


Affiliations: 1: Telfer School of Management, University of Ottawa, Ottawa, ON, Canada 2: Department of Finance, University of Quebec (Montreal), Montreal, Quebec, Canada

Publication date: April 3, 2014

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