Hedge Fund Investment: Optimal Portfolios with Regime-Switching

We investigate the benefits of including hedge funds into a portfolio of stocks, bonds, and commodities. We use a multivariate canonical vine copula regime-switching model which allows for non-linearity, asymmetry, and time variation in hedge fund returns. We find that the willingness to pay to access hedge funds is about 4 cents per dollar, and it increases with risk aversion; the weights in hedge funds show an inverse U-shape with risk aversion; hedge funds tend to replace stocks (bonds) for risk-averse (risk-tolerant) investors; investing in hedge funds increases historical returns only until 2008, but reduces volatility even after.