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The Journal of Alternative Investments

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Primary Article

Optimizing Benchmark-Based Portfolios with Hedge Funds

Ivilina Popova, David P. Morton, Elmira Popova and Jot Yau
The Journal of Alternative Investments Summer 2007, 10 (1) 35-55; DOI: https://doi.org/10.3905/jai.2007.688992
Ivilina Popova
An assistant professor of finance at Albers School of Business and Economics, Seattle University in Seattle WA.
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  • For correspondence: popovai@seattleu.edu
David P. Morton
An associate professor in the graduate program of operations research at The University of Texas in Austin, TX.
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  • For correspondence: morton@mail.utexas.edu
Elmira Popova
An associate professor in the graduate program of operations research at The University of Texas in Austin, TX.
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  • For correspondence: elmira@mail.utexas.edu
Jot Yau
A professor of finance at Albers School of Business and Economics, Seattle University in Seattle, WA.
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  • For correspondence: jyau@seattleu.edu
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Abstract

Hedge funds typically have non-normal return distributions marked by significant positive or negative skewness and high kurtosis. Mean-variance optimization models ignore these higher moments of the return distribution. This article introduces a new stochastic programming model which incorporates Monte Carlo simulation and optimization to examine the effects on the optimal allocation to hedge funds given benchmark related investment objectives such as expected shortfall and semi-variance. The results show that a substantial allocation—approximately 20% to hedge funds is justified. Specifically, the return distributions of portfolios constructed using the stochastic programming model skew to the right relative to those of the optimal mean-variance portfolios, resulting in higher Sortino ratios.

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The Journal of Alternative Investments
Vol. 10, Issue 1
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Optimizing Benchmark-Based Portfolios with Hedge Funds
Ivilina Popova, David P. Morton, Elmira Popova, Jot Yau
The Journal of Alternative Investments Jun 2007, 10 (1) 35-55; DOI: 10.3905/jai.2007.688992

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Optimizing Benchmark-Based Portfolios with Hedge Funds
Ivilina Popova, David P. Morton, Elmira Popova, Jot Yau
The Journal of Alternative Investments Jun 2007, 10 (1) 35-55; DOI: 10.3905/jai.2007.688992
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