TY - JOUR T1 - A Fund of Hedge Funds Under Regime Switching JF - The Journal of Alternative Investments SP - 8 LP - 23 DO - 10.3905/jai.2013.15.4.008 VL - 15 IS - 4 AU - David Saunders AU - Luis Seco AU - Christofer Vogt AU - Rudi Zagst Y1 - 2013/03/31 UR - https://pm-research.com/content/15/4/8.abstract N2 - This article investigates the use of a regime-switching model of returns for the asset allocation decision of a fund of hedge funds. In each time period, returns follow a multi-variate normal distribution from one of two possible regimes, corresponding to periods of “normal” and “distressed” markets. The prevailing regime in any given period is determined by the value of a two-state Markov chain. The case where serial correlation is absent and returns in different time periods are i.i.d. Gaussian mixture variables is also considered. The models are tested on empirical data and compared to a benchmark, assuming i.i.d. normally distributed returns. The results show that in a mean–variance framework, the use of regime switching can improve risk and performance measures. The importance of the sensitivity of optimal portfolio weights to the estimate of the probability of the distressed regime is discussed, and methods for calculating sensitivities are presented and illustrated on market data.TOPICS: Real assets/alternative investments/private equity, portfolio construction, statistical methods, financial crises and financial market history ER -