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Zbl 1151.91003
Lo, Andrew W.
Hedge funds. An analytic perspective. (English)
[B] Advances in Financial Engineering. Princeton, NJ: Princeton University Press. xxiv, 337~p. \sterling~26.95; \$~45.00 (2008). ISBN 978-0-691-13294-5/hbk

The book under review is highly interesting, it is the outgrowth of a research program of almost ten years. The author's style is great, in the sequel I will give a sample of some very lively quotes from the book. In the acknowledgements the author compares the hedgefund industry to the Galapagos islands, because of the remarkable speed and clarity with which evolution occurs in that business. \par Chapter 1 serves as an introduction, important key-words are tale risk, nonlinear risk, illiquidity and serial correlation. By means of a simple model the author describes so-called phase-locking behavior. This chapter ends with a brief literature review and the following sentence: ``Collectively, these studies show that the dynamics of hedge funds are quite different from those of more traditional investments, and the remaining chapters provide more detailed support for this claim". The second chapter describes basic properties of hedge funds returns. In this chapter the author mentions a Graveyard database, and a Live database. This chapter, as a lot to come, is filled with very instructive data about the hedge fund industry. \par The third chapter adresses serial correlation and illiquidity, and so called smoothed returns. Again a lot of data and empirical analysis. Chapter 4 is titled ``Optimal Liquidity", and introduces and estimates liquidity metrics. After that the author discusses Liquidity-Optimized Portfolios in a mean-variance framework. An important quote from this chapter: ``The dynamics of liquidity should also be modeled explicitly, in which case static mean-variance optimization may no longer be appropriate but should be replaced by dynamic optimization methods such as stochastic dynamic programming." The fifth chapter adresses the question whether hedge fund returns can be achieved without investing in hedge funds, in the words of the author: ``can hedge fund returns be `cloned'." The author implements a lot of clones and gives a careful analysis of the results. Chapter 6 has the title "A new measure of active investment management", it gives for example a new definition of passive investing and considers mean reversion and momentum strategies. This chapter also contains empirical applications. \par Chapter seven discusses systemic risk. A quote: ``Now if many funds face the same `death spiral' at a given point in time (i.e. if they become more highly correlated during times of distress) and if those funds are obligors of the small number of major financial institutions, then a market event like that of August 1998 can cascade quickly into a global financial crisis. This is {\it systemic risk}." In Chapter 8 the author proposes an ``integrated hedge fund investment process ", and gives ample illustration of this framework. \par Chapter 9 has the title ``Practical considerations", a quote: ``Hedge fund investors and managers often dismiss risk management as a secondary objective, with alpha or performance as the main objective." The author discusses the efficient market hypothesis in the light of the data concerning hedge funds. The last part of this chapter is called ``Regulating hedge funds". \par Apart from a useful appendix with an explanation of some important terms and some technical addenda, and a list of references, the book ends with chapter 10: ``What happened to the quants in august 2007 ." A quote: ``...risk has become `endogenous' in certain markets-particularly those that have recently become flush with large inflows of assets- which is one of the reasons that the largest players can no longer assume that historical estimates of volatility and price impact are accurate measures of risk exposure." I end this review of an important book with a last quote from the last chapter: ``Therefore, August 2007 offers a number of insights for improving the quantitative methods for measuring and managing risks. One of the most important lessons is the need for measures of illiquidity risk, and that volatility is an inadequate measure of risk...."
[Johannes W. Nieuwenhuis (Groningen)]

MSC 2000:: *91-01 Instructional exposition (Social and behavioral sciences)
91B28 Finance etc.

Keywords: hedge funds; econometrics; modeling.

Cited in: Zbl 1198.91001

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