Testing asset pricing models with hedge fund data and hedge fund performance

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Hedge funds have become significant investment instruments in asset management. The author explores three key questions: first, what asset pricing models can effectively measure hedge fund performance and their properties? Second, assuming suitable models are identified, what actual performance are we detecting? Do hedge funds truly exhibit higher abnormal returns as commonly claimed? Third, if superior risk-adjusted performance is detected, is it persistent, meaning does past overperformance predict future results? Through extensive theoretical and empirical analysis, the author demonstrates that consistent performance measurement of hedge funds falters at the outset, as no asset pricing model proves statistically significant. Consequently, according to capital market theory, these models are inadequate for performance assessment. Despite this, the author investigates whether hedge funds show superior performance compared to common benchmarks or performance attribution models. The findings indicate a small excess return against such factor models, but this outperformance is not considered alpha in the strict capital market sense; rather, it reflects relative outperformance. While some excess returns are evident, their persistence is weak and likely not economically exploitable. The results remain robust across various factor models, including both linear and regime-switching approaches, as well as parametric and non-paramet