Upside potential of hedge funds as a predictor of future performance

Turan G Bali, Stephen J Brown, Mustafa O. Caglayan

Research output: Contribution to journalArticleResearchpeer-review

Abstract

This paper investigates the relationship between upside potential and future hedge fund returns. We measure upside potential based on the maximum monthly returns of hedge funds (MAX) over a fixed time interval, and show that MAX successfully predicts cross-sectional differences in future fund returns. Hedge funds with strong upside potential generate 0.70% per month higher average returns than funds with weak upside potential. After controlling for alternative risk and performance measures, funds’ market-timing ability, and a large set of fund characteristics, the positive link between MAX and future returns remains highly significant. We conclude that MAX, as a simple proxy for realized noln-normalities in hedge funds, offers incremental information on future hedge fund returns above and beyond provided by standard risk, performance, and market-timing measures.

Original languageEnglish
Pages (from-to)212-229
Number of pages18
JournalJournal of Banking and Finance
Volume98
DOIs
Publication statusPublished - Jan 2019

Keywords

  • C13
  • G10
  • G11
  • Hedge funds
  • JEL classification:
  • Return predictability
  • Upside potential

Cite this

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abstract = "This paper investigates the relationship between upside potential and future hedge fund returns. We measure upside potential based on the maximum monthly returns of hedge funds (MAX) over a fixed time interval, and show that MAX successfully predicts cross-sectional differences in future fund returns. Hedge funds with strong upside potential generate 0.70{\%} per month higher average returns than funds with weak upside potential. After controlling for alternative risk and performance measures, funds’ market-timing ability, and a large set of fund characteristics, the positive link between MAX and future returns remains highly significant. We conclude that MAX, as a simple proxy for realized noln-normalities in hedge funds, offers incremental information on future hedge fund returns above and beyond provided by standard risk, performance, and market-timing measures.",
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Upside potential of hedge funds as a predictor of future performance. / Bali, Turan G; Brown, Stephen J; Caglayan, Mustafa O.

In: Journal of Banking and Finance, Vol. 98, 01.2019, p. 212-229.

Research output: Contribution to journalArticleResearchpeer-review

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