Financial Innovation and Hedge funds Academic Year: 2016/2017 4th trimester Instructor(s): Joni Kokkonen Course Description: The course provides an overview hedge funds and structured products. The course is divided into two major parts. The first one deals with hedge funds, their typical trading strategies, risk and return, historical performance, and portfolio decisions involving hedge funds. The second part of the course covers the basics of structured products and securitization. The focus in this part will be on the role of structured products in the recent financial crisis. Case studies and exercises are used to apply these concepts and methods to practical problems. Course objectives and learning goals: After taking the course, the student should Understand the basics of hedge funds. How has the market evolved in time, what are the typical strategies used and how do they work? Be able to measure and understand the risk and return characteristics of hedge funds. Understand the role of hedge funds in well-functioning capital markets. Understand the basics of the process of securitization. Be able to analyze different structured products and understand how they work. Understand some of the mechanisms underlying the financial crisis and the role of structured products. Prerequisites: Financial Investments and Financial Derivatives
Bibliography: Textbooks: Lhabitant, F.-S., 2006, Handbook of Hedge Funds, Wiley Finance (selected chapters) Lecture slides Articles indicated in this syllabus and any additional material indicated during the course. Course Content: Preliminary structure of the course: PART I: Hedge Funds I. Overview of the course and introduction to hedge funds Course overview Institutional and regulatory framework (hedge funds vs. mutual funds) Evolution and current state of the hedge fund market Benefits and risks of hedge fund investing a. Book: Chapter 2 b. Stulz, R. (2007), Hedge funds: past, present, and future, Journal of Economic Perspectives, 21, 175 194. c. Fung & Hsieh (1999), A primer on hedge funds, Journal of Empirical Finance, 6, 309 331. d. Kokkonen, J. and Suominen, M., Hedge funds and stock market efficiency, Management Science, forthcoming II. Hedge fund strategies Long/short equity and equity market neutral Dedicated short Fixed income and credit arbitrage Merger arbitrage and convertible arbitrage Global macro High-frequency trading Other strategies
a. Book: Chapters 5-17 b. Hasbrouck, J. & Saar, G (2011), Low-latency trading, working paper c. Kirilenko, A., Kyle, A.S., Samadi, M. & Tuzun, T. (2011), The flash crash: The impact of high frequency trading on an electronic market, working paper III. Hedge fund risk, return, and performance Overview of the historical performance of different strategies and their risks Risk-adjusted performance Selection bias and survivorship bias a. Book: Chapters 18 21 b. Asness, C., Krail, R. & Liew, J. (2001), Do hedge funds hedge?, Journal of Portfolio Management, 28, 6 19. c. Malkiel, B. & Saha A. (2005), Hedge funds: risk and return, Financial Analysts Journal, 61, 80 89. IV. Hedge funds and asset allocation Portfolio choice decisions involving hedge funds Diversification Limits of arbitrage a. Book: Chapters 22 24 and 26 b. Agarwal, V. & Naik, N. (2004), Risk and portfolio decisions involving hedge funds, Review of Financial Studies, 17, 63 98. c. Boyson, N.M., Stahel, C.W., & Stulz, R.M. (2010) Hedge fund contagion and liquidity shocks, Journal of Finance, 65, 1789 1816. d. Mitchell, M., Pulvino, T. & Stafford, E. (2002), Limited arbitrage in equity markets, Journal of Finance, 57, 551 584. e. Shleifer, R. & Vishny, R.W. (1997), The limits of arbitrage, Journal of Finance, 52, 35 55
PART II: Securitization, structured products, and the financial crisis V. Securitization Basics of the securitization process Overview of structured products a. Coval, J., Jurek, J. & Stafford, E. (2009), The economics of structured finance, Journal of Economic Perspectives, 23, 3 26. b. Rajan, R.G. (2006), Has finance made the world riskier?, European Financial Management, 12, 499 533. VI. Structured products and the financial crisis Overview of the causes of the financial crisis Role of financial innovation and structured products a. Brunnermeier, M. (2009) Deciphering the liquidity and credit crunch 2007 2008, Journal of Economic Perspectives, 23, 77 100. b. Demyanyk, Y. & Van Hemert, O. (2011), Understanding the subprime mortgage crisis, Review of Financial Studies, 24, 1848 1880. c. Spiegel, M. (2011), The academic analysis of the 2008 financial crisis: round 1, Review of Financial Studies, 24, 1773 1781. d. Diamond, D.W. & Rajan, R. (2009), The credit crisis: Conjectures about causes and remedies, NBER working paper 14739. Grading: Group exercises (45%) Final exam (55%)
Contact(s) and Office hours: joni.kokkonen@ucp.pt Office hours: by appointment Office: 5305