Market-Neutral Hedge Funds

Course Number: MGT 645

Zhiwu Chen

ICF room 204, 46 Hillhouse Ave
203-432-5948
zhiwu.chen@yale.edu
 

TA: Steve Yun
 

Time and Place: Wednesday, 4:10 to 7:10, Room A-30

Course Overview

An in-depth study on the theory and management of hedge funds, in particular market-neutral funds and funds with various controled levels of risk exposure. We will focus on their controled-risk strategies, including equity strategies (market-neutral and risk arbitrage), derivatives arbitrage, convertible arbitrage, fixed income arbitrage, and currency and global macro arbitrage. We will pay particular attention to issues at the operational level. Topics will include hedge fund compensation, performance evaluation, risk management, and the role of arbitrageurs in the capital market.

Assignments: Grades will be based on a project and two cases, with the project contributing 50% and the two cases each contributing 15% to the final grade. Class participation makes up the rest (20%). The project and the cases will be done in groups of 2, but no more than 3. For each case, two groups will be selected to do a presentation in class.

The course project involves four steps. Step 1:  select a stock return forecasting model (based on your own experience and reading of the literature, or based on your own research to select forecasting factors). You may also do some back-testing of your strategy before taking the next step to make sure that you can have enough confidence in your model and strategy. Step 2:  form your equity market-neutral strategy, based on the risk factors that you select. Once you have done this part, write a report summarizing your model's various aspects and detailing your market-neutral portfolio's positions and risk profile. You want to write this first report as if you were trying to sell your hedge fund strategy to potential clients. This report is submitted as a first part of the project. The portfolio positions should be e-mailed to our TA in electronic format. Step 3: track your fund's daily performance on Yahoo finance or another website of your choice, and record the performance numbers. You should also track the daily changes in the market indices that you may later need to evaluate your fund's performance. Before the end of November, you can make changes to your portfolio positions. But, if and when you make changes, there is a 0.5% transaction fee and also you will need to e-mail your TA the changes. Step 4: evaluate your market-neutral strategy's performance based on the daily performance from Oct 7 to the end of November. We will use the S&P 500 and the NASDAQ Composite index as the two factors to take out the performance that is due to systematic risk. After doing the performance evaluation, write a second report summarizing the performance evaluation results and the lessons from the project. Then, turn in the second report. The group that has the highest risk-adjusted excess return will get a distinction for the course.
 
 

Text: Joseph Nicholas, Market-Neutral Investing: Long/short hedge fund strategies

Suggested additional reading: Jaeger, Robert, All About Hedge Funds

 
 

Sept. 3:  Introduction

 

Sept. 10:  Equity return models and stock selection

Sept. 17: Risk models, risk controls and portfolio construction

Sept. 24: Market impact/slippage costs, and trading strategies and systems

Powerpoint Presentation for Price Impact and Fund Size,

Oct. 1:   Speaker on trading costs and trading strategies:  Dr. Ian Domowitz, Managing Director of Research and Trading Systems, Investment Technology Group (ITG). http://www.itginc.com Dr. Domowitz recently left Penn State to join ITG full-time. You can find more about his background from a previous webpage of his.

You can download the PPT presentation file by Dr. Domowitz

Oct. 8: Merger/risk arbitrage (and First Report of the Course Project on equity market-neutral portfolio is due)

Oct. 15:  Risk Management in practice. Guest speaker: Dr. Barry Schachter, Managing Director of Risk Management, SAC Capital Advisors;

Formerly, head of enterprise risk management, Caxton Associates; Chase Manhattan Bank, responsible for portfolio market risk management, VaR model, stress testing, market risk economic and regulatory capital; Comptroller of the Currency, responsible for evaluation of bank market risk measurement systems; Commodity Futures Trading Commission, acting head of economic research group and project leader for OTC derivatives study; Ten years in academia teaching and doing research in derivatives and risk management.  Check out Barry Schachter's website: http://www.gloriamundi.org/


Here is Barry's PPT file you can download.

Oct. 22:  Speaker on fixed-income & currency arbitrage: Dr. Joe Zhou, chairman of Divergence Capital Management, (formerly with Quantitative Financial Strategies).

You can download the PPT presentation file by Dr. Zhou. This is a simple outline, and examples will be given in class. You can also read a short write-up for his presentation.

 

Oct. 29: First case presentation (Orange County case due) at the beginning of class

Orange County Case Philippe Jorion's Orange County Case: Using Value-At-Risk to Control Financial Risk.

* Hedge Funds and the Asian Currency Crisis of 1997 , Stephen J. Brown and William N. Goetzmann.
 

* Fixed-income arbitrage strategies

     Slides for this topic are in part 1 and part 2.

 Then for the remainder of the class: Index futures arbitrage and options arbitrage

Nov. 5:  no class

 

Nov. 12: Options arbitrage continued, and convertible bond arbitrage

Nov. 19:  Fund of funds strategies, options strategies, and hedge fund operational issues

Some materials to be distributed in class. On fund operational risk management, see the slides by clicking here. 

Dec. 3:  James Park, founder and chairman of Paradigm Advisors

Here are three articles to read: .
"Setting a New Standard?"  and
"Modern Portfolio Theory and its Applications to hedge funds" by Jame Park: "Part I"  and "Part II "

Additional reading materials are distributed in my e-mail.
 

Dec. 10:  Hedge fund performance evaluation, and second case presentation (the HBS Common Fund case). Questions to work on for the case are here.

Performance Evaluation. linear models, attribution analysis, benchmarking trend followers. For an easy-to-read article on the Sharpe Ration, see http://www.investopedia.com/offsite.asp?URL=http://www.venus.it/homes/ik2hlb/sr.htm 

Dec. 16:  Second report of the Course Project (performance analysis) is due. No final exam.