« Does Variance Risk Have Two Prices? Evidence from the Equity and Option Markets », 2016, Journal of Financial Economics 121, 79-92, with A. Malkhozov
We formally compare two versions of the market Variance Risk Premium (VRP) measured in the equity and option markets. Both VRPs follow common patterns and respond similarly to changes in volatility and economic conditions. However, we reject the null hypothesis that they are identical and find that their difference is strongly related to measures of the financial standing of intermediaries. These results shed new light on the information content of the VRP, suggest the presence of market frictions between the two markets, and are consistent with the key role played by intermediaries in setting option prices.
« Hedge Fund Return Predictability Under the Magnifying Glass », 2013, Journal of Financial and Quantitative Analysis 48, 1057-1083, with D. Avramov and R. Kosowski
This paper develops a unified approach to comprehensively analyze individual hedge fund return predictability, both in- and out-of-sample. In-sample, we find that variation in hedge fund performance across changing market conditions is both widespread and economically significant. The predictability pattern across funds is consistent with economic rationale, and largely reflects differences in key hedge fund characteristics, such as leverage or capacity constraints. Out-of-sample, we show that a very simple strategy that combines the funds’ return forecasts obtained from individual predictors delivers superior performance, even during the 2008 financial crisis. Importantly, we show that in- and out-of-sample predictability are closely related, contrary to the results documented in the previous literature.
« False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas », 2010, Journal of Finance 65, 179-216, with O. Scaillet and R. Wermers
Winner of the 2008 Swiss Finance Institute/Banque Privée Espirito Santo Outstanding Paper Award
This paper develops a simple technique that controls for « false discoveries, » or mutual funds that exhibit significant alphas by luck alone. Our approach precisely separates funds into (1) unskilled, (2) zero-alpha, and (3) skilled funds, even with dependencies in cross-fund estimated alphas. We find that 75% of funds exhibit a zero alpha (net of expenses), consistent with the Berk and Green (2004) equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. We also show that controlling for false discoveries substantially improves the ability to find funds with persistent performance.
« International Conditional Asset Allocation Under Specification Uncertainty », 2007, Journal of Empirical Finance 14, 443-464
This paper examines the impact of specification uncertainty on the performance of international mean-variance conditional asset allocation. This notion is defined as the uncertainty faced by the investor regarding the specification choices necessary to implement a conditional strategy. To assess the impact of this phenomenon, we measure the performance of a group of strategies that the investor could reasonably consider. The strong performance variability across the strategies indicates that the gains previously documented are overstated. Our findings provide an explanation to the apparent paradox between the economic and statistical significance of predictability, and are consistent with the semi-strong form of market efficiency.
« How to Diversify Internationally? A Comparison of Conditional and Unconditional Asset Allocation Methods », 2003, Financial Markets and Portfolio Management 17, 194-212, with D. Isakov
To obtain the maximum benefits from diversification, financial theory suggests that investors should invest internationally because of the larger potential for risk reduction. The question that we raise in this paper is how to select the optimal portfolio of developed and emerging countries? This article synthesizes the major international asset allocation methods based on mean-variance analysis that have been proposed so far in the literature. In particular it compares two types of conditional asset allocation with unconditional methods. The asset allocation methods are implemented from a Swiss perspective over the period 1988-2001. We find that conditional methods based on direct predictability of expected returns outperform all other asset allocation methods.