Angelo Ranaldo – University of St. Gallen; University of St. Gallen – SoF: School of Finance & Laurent Favre – AlternativeSoft AG
The authors conclude that in the CAPM model, it is hard to explain the superior paste performance of hedge funds. They argue that the Markowitz mean-variance criterion underpinning the traditional CAPM may fail to capture systematic features characterizing hedge fund performance. Thus, they extend the two-moment market model to a higher-moment model to accommodate coskewness and cokurtosis. The higher-moment approach is more appropriate for capturing the non-linear relation between hedge fund and market returns and accounting for the specific risk-return payoffs of each hedge fund investment strategy. The key result is that the sole use of the two-moment pricing model may be misleading and may wrongly indicate insufficient compensation for the investment risk.