This paper provides a new hedge fund replication method, which extends Kat and Palaro (2005) and
Papageorgiou, Remillard and Hocquard (2008) to multiple trading assets with both long and short
positions. The method generates a target payoff distribution by the cheapest dynamic portfolio. It is
regarded as an extension of Dybvig (1988) to continuous-time framework and dynamic portfolio
optimization where the dynamic trading strategy is derived analytically by applying Malliavin calculus. It
is shown that the cost minimization is equivalent to maximization of a certain class of von
Neumann-Morgenstern utility functions. The method is applied to the replication of a CTA/Managed
Futures Index in practice.
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