Are Shocks to Hedge Fund Returns Permanent or Temporary?

This paper seeks to ascertain whether shocks to hedge fund returns are permanent or temporary by using M1 and M2 unit root procedures advanced by Narayan and Popp. In addition, the paper implements the GARCH-based unit root test developed by Liu and Narayan. These procedures allow for two structural breaks in the data. The results from M1 and M2 models indicate that the various hedge fund returns under study are stationary processes with two structural breaks. Similarly, the results from the GARCH-based unit root model confirm those obtained from both the M1 and M2 techniques in that the hedge fund return series were found to be stationary. Taken together, the results suggest that shocks to the various hedge fund returns are temporary. This finding implies that hedge funds can be included in portfolios with traditional assets such as stocks and bonds to reduce risk and enhance returns.