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Rev Fin 2001; 14:313-341
© 2001 the Society for Financial Studies

Article

The risk in hedge fund strategies: theory and evidence from trend followers

W Fung1 and DA Hsieh2,z
1 PI Asset Management, LLC
2 Fuqua School of Business, Duke University, Box 90120, Durham, NC 27708-0120, USA
z Corresponding author
E-mail: david.a.hsieh@duke.edu

Abstract

Hedge fund strategies typically generate option-like returns. Linear-factor models using benchmark asset indices have difficulty explaining them. Following the suggestions in Glosten and Jagannathan (1994), this article shows how to model hedge fund returns by focusing on the popular 'trend-following' strategy. We use lookback straddles to model trend-following strategies, and show that they can explain trend-following funds' returns better than standard asset indices. Though standard straddles lead to similar empirical results, lookback straddles are theoretically closer to the concept of trend following. Our model should be useful in the design of performance benchmarks for trend-following funds.


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