Hedge fund strategies, performance & diversification: a portfolio theory & stochastic discount factor approach

David Newton, Emmanouil Platanakis, Dimitrios Stafylas, Charles Sutcliffe*, Xiaoxia Ye

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review


For 5500 North American hedge funds following 11 different strategies, we analyse the stand-alone performance of these strategies using a stochastic discount factor approach. Employing the same data, we then consider the diversification benefits of each hedge fund strategy when combined with a portfolio of US equities and bonds. We compute the out-of-sample Black-Litterman portfolios, with Bayes-Stein, higher moments, simulations, desmoothed data and allowance for regimes as robustness checks. All but two hedge fund strategies out-perform the market as stand-alone investments; and all but one provide significant diversification benefits. The higher is an investor's risk aversion, the more beneficial is diversification into hedge funds.

Original languageEnglish
Article number101000
JournalBritish Accounting Review
Issue number5
Publication statusPublished - 24 Sept 2021

Bibliographical note

Funding Information:
We wish to thank the referee and participants at the British Accounting and Finance Association (BAFA) Corporate Finance and Asset Pricing Conference 2019, the 26th Annual Global Finance Conference (Zagreb), and the 9th International Conference of the Financial Engineering and Banking Society (Prague) for their valuable comments on earlier versions of this paper.

Publisher Copyright:
© 2021 British Accounting Association


  • Bayes-Stein
  • Black-Litterman
  • Hedge funds
  • Portfolio diversification
  • Stochastic discount factors

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