Product Description

The hedge fund industry has grown dramatically over the last two decades, with more than eight thousand funds now controlling close to two trillion dollars. Originally intended for the wealthy, these private investments have now attracted a much broader following that includes pension funds and retail investors. Because hedge funds are largely unregulated and shrouded in secrecy, they have developed a mystique and allure that can beguile even the most experienced investor. In Hedge Funds, Andrew Lo--one of the world's most respected financial economists--addresses the pressing need for a systematic framework for managing hedge fund investments.

Arguing that hedge funds have very different risk and return characteristics than traditional investments, Lo constructs new tools for analyzing their dynamics, including measures of illiquidity exposure and performance smoothing, linear and nonlinear risk models that capture alternative betas, econometric models of hedge fund failure rates, and integrated investment processes for alternative investments. He concludes with a case study of quantitative equity strategies in August 2007, and presents a sobering outlook regarding the systemic risks posed by this industry.

Product Details

• Amazon Sales Rank: #23979 in Books
• Published on: 2008-04-28
• Format: Illustrated
• Original language: English
• Number of items: 1
• Binding: Hardcover
• 364 pages

Review
Anyone who is considering investing in hedge funds, or is involved in regulating the financial-services industry, should give it a go.
(The Economist )

The book is the authoritative distillation into an accessible form of a huge amount of academic research and practical experience. . . . Professor Lo gives a masterful illustration of the problems in gauging hedge fund performance with his famous fantasy fund Capital Decimation Partners.
(Steven Bell The Business Economist )

For scholars already familiar with the concepts of modern portfolio theory, the book is a good start in a quest to expand their knowledge of hedge funds strategies. . . . As one of the leading researchers in the field, Lo sets the standard by establishing key concepts for the industry with this book.
(Marcel Mollenbeck Financial Markets and Portfolio Management )

Review
Andrew Lo's Hedge Funds is likely to be the high-water mark in the analysis of hedge funds for years to come. Focusing on hedge fund returns and trading strategies, risk characteristics, and potential for illiquidity, Lo brings to bear his always fresh and insightful thinking.
(Richard Bookstaber, author of "A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation" )

From the Inside Flap

"Andrew Lo's Hedge Funds is likely to be the high-water mark in the analysis of hedge funds for years to come. Focusing on hedge fund returns and trading strategies, risk characteristics, and potential for illiquidity, Lo brings to bear his always fresh and insightful thinking."--Richard Bookstaber, author of A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation

"Lo offers a truly unique perspective. He examines the properties of returns and illiquidity in great detail and introduces an innovative concept of mean-variance-liquidity optimization, something that no other book on hedge funds has addressed."--Narayan Y. Naik, London Business School

"This book provides a useful and very timely overview of key aspects of the hedge fund industry. It summarizes the basic properties of hedge fund returns, discusses why traditional performance measures may be misleading when analyzing hedge fund performance, and highlights important issues such as serial correlation, return smoothing, and illiquidity."--Markus K. Brunnermeier, Princeton University

Customer Reviews

Not as Interesting As One Would Think
Let me start by saying that for someone wanting to learn about hedge funds, this book will still give you a decent amount of knowledge and a lot of empirical results. In fairness, the author has done a good amount of research on the subject, but I did not get the sense of a compelling consensus that these results are robust. What this book is good for is to gain an understanding of the databases that provide useful hedge fund information. So if you want to conduct your own empirical studies, yo will know where to go. This book does not seem to be as exceptional as the author's other books (e.g. Econometrics of Financial Markets).

real analysis on hedge funds - no fluff
This is a thorough analysis of a number of different hedge fund strategies and a preview of the topics likely to be heavily discussed by hedge fund managers, pension plans as they move into the space, consultants advising plans, and fund of funds players.

Puts alot of meat on the bones of many issues those in the hedge fund business are currently discussing and grappling with in order to refine their business processes.

Very well researched and well written. Good analysis of the debacle of quant funds in 2007.

Interesting and informative
The recent financial "crisis" has many pointing to hedge funds as being one of the many culprits in bringing about the "freeze-up" in credit, along with ordinary banks and insurance providers. In spite of their being around for many decades, hedge funds still seem mysterious to many, and this has caused many to view them with (unjustified) suspicion. Even financial modelers and analysts who work in areas outside of hedge funds sometimes view them this way.

This book is written for the latter class of readers. The author, a respected researcher in his own right and one who many readers may find familiar because of his earlier book "A Non-Random Walk Down Wall Street", gives a fairly detailed introduction to some of the quantitative analysis behind hedge funds. The mathematical formalism used in the book should be familiar to the typical financial engineer, but some of the emphasis, particularly on serial correlations, may be surprising to those analysts who have not had to deal with it in practice.

But the author views serial correlation as being one of the most important characteristics of hedge fund returns, and he gives a fair amount of empirical evidence for his assertion early in the book. He makes it clear however that the presence of serial correlation does not necessarily invalidate the random walk hypothesis (i.e. the presence of predictability in returns), but instead is manifested in the presence of illiquid securities in the hedge fund. Serial correlation thus becomes a proxy for the liquidity exposure of a hedge fund. The author also takes into account the fact that `performance smoothing' may be responsible for serial correlation in the reported returns of hedge funds. A linear single-factor model, the details of which are discussed in chapter three of the book, is used to model these possibilities.

For those readers such as this reviewer who are strong advocates of complete automation of trading in the financial markets, chapter ten of this book should be of great interest. It gives in the author's words a tentative explanation for some of the peculiar events that were happening last year at this time in some of the "quant funds", particularly those that deployed what have been called `statistical arbitrage strategies." What is valuable about the author's discussion in this chapter is that he is honest enough to admit his explanations are tentative, and he avoids the hype of the popular and financial presses at the time. One headline in particular made the point that complex mathematical formulas "failed" Wall Street while another spoke of the "miscalculations" of Wall Street's "math brains." There is no doubt that the events of August 6-10, 2007 surprised many, including some of the managers and modelers of these quant funds, but others believe, correctly, that such large sways in losses should be viewed as part of the dynamics of the financial markets of the twenty-first century. Events like those in August 2007 will just be something traders will have to get used to, until the full automation of the financial markets can be completed, after which any anxieties will arise from those whose fortunes may be depleted from the trading strategies of the machines participating in this automation.

The author does not say much about automation in this article, except to give justified praise to those mathematicians, programmers, and managers who worked together to bring about automated trading platforms. Instead the author wants to enlighten readers who may not have in-depth knowledge of `long/short equity" strategies and their role in the events of August 2007. The mathematics is kept at a fairly elementary level, with most of the space in the chapter devoted to narrative explanations rather than mathematical formalism. The author delegates more of the mathematical details to the appendices. All of discussion in this chapter is fascinating, especially the comparisons of the August 2007 events to those in the Long Term Capital Management debacle in 1998. The latter has been used as a kind of benchmark for the modeling of extreme events in the financial markets, and how tightly coupled different sectors of these markets can be. The author alludes to this coupling in his `unwinding hypothesis', wherein the rapid unwinding of any equity portfolio can affect all other quantitative strategies (so-called "common factor exposures"). The obstruction to validating his hypothesis is the proprietary nature of hedge funds, with each one guarding their own algorithmic secrets passionately, but yet who endeavor always to "reverse engineer" the others.

It is this lack of data and the asserted entanglement between different hedge funds that causes the author to discuss a very interesting tool in the mathematical modeling of creditor and illiquidity risk in hedge funds: the mathematical theory of networks. This reviewer, who has in times past worked in network modeling for several years, finds this an exciting development, and further proof of the interdisciplinary nature of today's modeling efforts. Of course when one is modeling networks one is usually given the network topology and then endeavors to understand the information flow across the different devices (or nodes) in the network. However, when applying networks to the hedge fund industry one does not have information on the network topology due to the lack of transparency. The author of course realizes this and corrects for it by calculating the absolute values of the correlations between the hedge fund indexes over time. This gives him a notion of the "degree of connectedness" in the hedge fund industry, and he gives some (pictorial) examples. Simulations using artificially generated data from Monte Carlo simulations may be of assistance here in studying the degree of connectedness, in lieu of real data from the hedge funds themselves (which may not be farfetched given the regulatory threats hedge funds now face).

Since the author is heavily involved in the analysis of hedge funds it is natural to expect him to devote some space in the book to addressing the question as to whether the quant funds did indeed fail. In this regard he views the events of August 2007 as reflecting the liquidation of portfolios that were constructed using quantitative methods. The strength of quantitative methods remains to be tested, and also successful risk strategies must be devised that reflect the large deviation events that might occur in hedge funds.

This review is based on a reading of four chapters of the book.