The expanding (alpha) universe
Dec 23rd, 2007 | Filed under: CAPM / Alpha TheoryApparently, the universe is big. Really big. We learned this week that it holds about 10^80 atoms (see previous posting). But how big is the alpha universe? How much alpha can possibly be generated by hedge funds (or any active manager)? Neither universe is easy to get your head around and neither can be measured directly.
We tackled this question about a year ago in relation to a seminal white paper written by Lars Jaeger and Christian Wagner (see related posting). But we thought it would be interesting to revisit this given the myriad of new estimates that have recently come out on the size of the hedge fund industry.
To get to the bottom of this, we went right to the expert on the topic, Hilary Till of Chicago-based Premia Capital Management. Till wrote a paper back in 2004 for both the Journal of Alternative Investments and the AIMA Journal on the theoretical capacity of the hedge fund industry. The AIMA Journal version of the piece was called “The Capacity Implications of the Search for Alpha” and Jaeger and Wagner actually cite it when establishing a conceptual framework on hedge-fund capacity.
In a summary of 2004 article (available here) Till says:
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