Hedge Fund Replication: Putting the Pieces Together
In this paper, we aim to bring together into one common framework various advances in factor-based hedge fund replication. Our replication methodology relies on a set of investable dynamic risk factors extracted from futures contract prices and on an automatic variable and model selection procedure. The methodology is then validated by creating out-of-sample replicating portfolios for the monthly returns of more than 7,000 hedge funds ranging from 2006 to 2012 and under the assumption of transaction costs. Our results suggest that hedge fund replication is on average possible and works best for liquid strategies.