Trading off accuracy for speed: Hedge funds' decision-making under uncertainty

Active managers operating quick portfolio adjustments, backed only by some rough estimates and loose predictions, might improve their market timing performances to benefit in turbulent times, but oversimplification can lead to an inability to profit in calm markets. By selecting accuracy levels upfront, through different data-filtering techniques, we expose a trade-off between prediction accuracy and reaction speed across different hedge funds' investment styles. Our empirical analysis shows that less accurate predictions can speed up reactions to unexpected changes in a large set of uncertainty and risk measures. We justify and complement these findings with a simulation exercise.

Automated summary

Active fund managers may improve market timing performance by making quick portfolio adjustments backed by rough estimates, but oversimplification could lead to inability to profit in calm markets. Selecting accuracy levels upfront through different data-filtering techniques can expose a trade-off between prediction accuracy and reaction speed across hedge funds' investment styles. Less accurate predictions may speed up reactions to unexpected changes in uncertainty and risk measures, as shown in empirical analysis and complemented by simulation exercises.