Raphaële Chappe

Disparity in Wealth Accumulation: A Financial Market Approach

In this paper we study the extent to which the financial market has contributed to wealth disparities. To that end we introduce a stochastic dynamic model of wealth accumulation with preferences, consumption and portfolio choice, which roughly replicates the long-term evolution of assets under management. Using an algorithm for solving nonlinear model predictive control, we run simulations with three classes of investors (conservative, moderate and aggressive) corresponding, roughly, to the social classes identified in Piketty (2013) for thinking about distributional matters, namely the lower class (bottom 50 percent), the middle class (middle 40 percent), and the upper class (upper 10 percent) respectively. We estimate the impact on the end wealth distribution of first, investor-level characteristics (calibrated for each investor class), which directly impact the saving rate; and second, higher expected returns for wealthier (aggressive) investors in the top decile through the availability of leverage. We find that differences in investor-level characteristics (and significantly the length of the optimization horizon) combined with access to leverage are sufficient to generate fat tails. Though results are obtained in a stochastic approach, the outcomes are less related to stochastic shocks than to some feedback and scale effects operating in favor of some investors in the financial market.

PONZI FINANCE AND THE HEDGE FUND INDUSTRY

This paper presents a stochastic dynamic model that can be used to describe situations in asset management where hedge funds may inadvertently find themselves running a Ponzi financing scheme. Greater transparency is necessary to reduce such opportunities, such as audited financials, and disclosure of valuation methodologies. In that respect, new regulatory frameworks enacted by the Obama administration and the European Union are welcome developments.

The Operation of Hedge Funds: Econometric Evidence, Dynamic Modeling, and Regulatory Perspectives

The Madoff case has all the makings of a Ponzi scheme. Ponzi schemes follow what Hyman Minsky described as Ponzi finance. Do hedge funds, or at least some of them, follow a similar scheme? The best summary of different financing practices, such as hedge, speculative, and Ponzi financing, is given in Minsky (1986). Hedge finance is a situation where operating cash flow can service all payment obligations associated with the financing. Speculative finance involves situations where operating cash flow supports interest payments but not repayment of principal. Ponzi finance describes a situation where operating cash flow is insufficient to cover either principal or interest payments, which can be financed only via an increase in liabilities, thus by a new inflow of funds.

Chapter 19 – ‘Seeking Alpha’: The Performance of Funds of Hedge Funds

As for other active investment portfolios, hedge fund performance is typically measured by alpha and beta coefficients. Roughly, the beta and alpha terms measure the passive and active components of the return, respectively. Presumably, it is the ability to deliver high alphas that is responsible for the rise of the hedge fund industry. Our goal is to test this hypothesis for funds of hedge funds (FoHFs) and determine whether we can confirm statistically significant positive alphas. By using monthly returns from November 2002 to February 2012 for a sample of 5509 FoHFs combining both active and inactive (defunct) funds in the Bloomberg database, we estimate a linear ‘risk’ multifactor model to provide a decomposition of fund return between a passive portfolio of indices, and manager-specific alpha. We perform a time-series regression by ordinary least squares (OLS) for each fund in our sample, regressing monthly returns against eight indices. We can confirm statistically significant positive alphas for only 506 out of 5509 funds in our sample, which is not even 10% of them. This would suggest that investors should not automatically assume that all FoHFs are able to select the best-performing hedge funds, but instead should carefully pick those funds that will create manager-specific alpha.