Alternative Asset Pricing: Momentum and the Hedge Fund Puzzle

Abstract

This article examines the effect of including hedge funds in the investment pool on the asset return bounds implied by established finance theory. Bounds are violated in a way that is difficult to explain in the usual manner, thus suggesting that a modified framework is needed. The authors include commodities as well as stocks among the set of investable assets. Empirical tests of the momentum strategy consistently outperform the market over the past 10 years, including the meltdown of 2008. The results have implications for current regulations and their effectiveness with respect to the stated goal of protecting the public. The authors’ findings support the idea of relaxing regulations based on the free-rider effect, which provides an efficient solution to the risk minimization problem, given that a smaller information set is available to the common investor.