Net Inflows and Time-Varying Alphas: The
Case of Hedge Funds∗
and Claudio Morana‡
October 1, 2006
The growth in the size of the hedge funds industry has led some investors
to worry about a decline in alphas, associated with reduced arbitrage
opportunities in international financial markets. We introduce a
multivariate components model for returns and net relative inflows into
hedge funds, accounting for time-varying market premia.
We estimate alpha as an unobserved component variable of the econometric model. We
then assess whether several categories of hedge funds do produce extra
profits and whether the flows of funds into the industry are dynamically
related to returns.
Our results point to a positive correlation between
past returns and future flows, while the evidence concerning the linkage
between past flows and future returns is mixed. However, we do not find
any structural decline in alpha for most hedge fund categories.
Key words: Hedge funds, performance, asset pricing models, unobserved
JEL classification: G2; G11; G15; C32