Discussion Paper

Risk measurement illiquidity distortions

Abstract: We examine the effects of smoothed hedge fund returns on standard deviation, skewness, and kurtosis of return and on correlation of returns and cross-sectional volatility and covariance of returns using an MA(2)-GARCH(1,1)-skewed-t representation of returns instead of the traditional MA(2) model employed in the literature. We present evidence that our proposed representation is more consistent with the behavior of hedge fund returns and that the traditional method tends to overstate the degree of smoothing observed in hedge fund returns. We present methods for correcting for the distortive effects of smoothing using our representation.

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Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Occasional Papers

Publication Date: 2012

Number: 12-2