Ebook Time-variation in hedge fund risk exposures
The hedge fund industry has received a lot of attention both inside and outside the academic world. The attack of George Soros’ Quantum Fund on the pound sterling in 1992 and the collapse of Long-Term Capital Management as a consequence of the Russian debt crisis in 1998 heightened the public and academic interest in hedge funds. During the past decade, hedge funds also have attracted more attention because they ever more attempt to influence the organisational, financial and operational activities of corporations by means of shareholder activism. Just one example of this is hedge fund TCI Fund Management demanding a breakup of Dutch bank ABN AMRO in 2007.
Hedge funds are largely unregulated. They are able to create leverage, use derivatives and short positions. Their investment strategies are therefore typically very dynamic in nature. This circumstance makes it very likely that the risk exposures of hedge funds are not stable over time. For purposes of portfolio construction, risk management and performance evaluation it is very important to have a good understanding of hedge fund risk profiles. Previous studies have indicated that models assuming a linear relationship between risks factors and hedge fund returns indeed do not perform very well. This study is aimed at finding time-variation in hedge fund risk exposures. There has not been a lot of research explicitly concerned with such time-variation. The results of these few studies indeed suggest that the risk exposures of hedge funds depend on the investigated time frame. This is the first study that finds results using a dynamic model in which risk exposures are allowed to change on a month-to-month basis. This involves a maximum likelihood estimation in a behavioural framework.
The model finds significant and robust time-variation in the risk exposures of the global/macro and short bias hedge fund styles. This study provides evidence that hedge fund managers of these styles change their strategies on the basis of their performance relative to the performance of alternative strategies. The changes are both statistically and economically significant. These results are robust since similar results are found in two datasets from two different data vendors.
This thesis is as organised follows. Chapter 2 gives a general introduction by treating the characteristics of hedge funds. Previous literature closely related to this study is described in Chapter 3. In Chapter 4 the data and methodology of this study are developed. Chapter 5 elaborates on the estimation results. Chapter 6 provides a summary and conclusions.
contents
Abstract
Table of contents
List of Tables
List of Figures
1 Introduction
2 Introduction to hedge funds
2.1 What characterizes a hedge fund?
2.2 Data issues in hedge fund research
- 2.2.1 Survivorship bias
2.2.2 Self-selection and backfill bias
2.2.3 Return smoothing
2.3 Statistical properties of hedge fund returns
- 2.3.1 Individual hedge fund returns
2.3.2 Index returns
2.4 Performance and persistence
2.5 Management performance incentives
3 Literature review
3.1 Style analysis
3.2 Time-variation
- 3.2.1 Time-variation in hedge fund research
3.2.2 Time-variation in heterogeneous agents literature
4 Data and methodology
4.1 Methodology
4.2 Data
5 Results
5.1 Linear regression model
- 5.1.1 Convertible arbitrage
5.1.2 Equity market neutral
5.1.3 Event driven
5.1.4 Emerging markets
5.1.5 Global/macro
5.1.6 Short bias
5.1.7 Results of the CS/Tremont sample
5.1.8 Summary on the linear regression results
5.2 Time-varying model
- 5.2.1 Factor loadings
5.2.2 Switching behaviour
6 Summary and conclusions
Literature
Appendices
- Appendix A.1 Non-directional trading styles
Appendix A.2 Directional trading styles
Appendix B Weights descriptive statistics global/macro style (CS/Tremont)
Appendix C Weight correlations global/macro style (CS/Tremont)
Appendix D Weights global/macro style (CS/Tremont)
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