Can Investing in Hedge Funds Improve Efficiency for Economically Important Investors

The purpose of this paper is to examine the performance of hedge funds from the efficient diversification point of view for economically important investors, which is defined as in Tsetlin et al. (2015). We adopt the generalized almost second-degree stochastic dominance (GASSD) rule proposed by Tsetlin et al. (2015). The rule includes second-degree stochastic dominance as a special case and is a consensus rule for all economically important investors. We establish statistical estimations and tests for the GASSD efficiency of a given portfolio relative to all possible portfolios formed from a given set of assets. We find that for all economically important investors, adding hedge funds to a diversified portfolio can improve efficiency. The results explain the popularity of hedge funds in practice. JEL Classification: D80, D81