Risk and Beta Anatomy in the Hedge Fund Industry

EMFI Working Paper No. 1 - 2009

The European Journal of Finance, Forthcoming, DOI:10.1080/1351847X.2011.649216

62 Pages Posted: 2 Apr 2010

See all articles by Roberto Savona

Roberto Savona

University of Brescia - Department of Economics and Management

Multiple version iconThere are 2 versions of this paper

Date Written: June 30, 2009

Abstract

Using a Bayesian time‐varying beta model, we explore how the systematic risk exposures of hedge funds vary over time conditional on some exogenous variables that managers are assumed to use in changing their trading strategies. In such a setting, we impose a structure on fund returns, betas and benchmark returns, developing a framework that could help explain how expected and unexpected hedge fund returns are correlated with systematic risk factors through the beta dynamics. Such a system also provides a useful way of (a) inspecting how and through which channels systemic risk propagates over time; (b) evaluating the performance conditional on public information within a Bayesian context; (c) cloning hedge funds by means of beta replication; (d) monitoring the risk of hedge fund returns in a VaR‐based context. The major findings of this work, based on the analysis of the CSFB/Tremont indices over the period January 1994-September 2008, are that: (1) volatility, changes in T‐bill, term spread and shocks in liquidity significantly impact on the time variation of hedge fund betas; (2) increasing interdependencies in beta dynamics among hedge funds together with leverage levels and shocks in liquidity are the key factors underlying the dynamics of systemic risk; (3) conditional time variation in betas leads to the conclusion that the hedge fund industry did not deliver excess returns over its own style benchmark; (4) replicating the risk/return characteristics of hedge funds through our beta modeling seems to do a good job, also delivering better performances on a risk‐adjusted basis; (5) simulation‐based exercises on VaR predictions prove that our technology could be a serious candidate in hedge fund risk‐monitoring systems.

Keywords: Bayesian Analysis, Conditional Timevarying Beta, Hedge Funds, Performance, VaR

JEL Classification: C11, C13, G12, G13

Suggested Citation

Savona, Roberto, Risk and Beta Anatomy in the Hedge Fund Industry (June 30, 2009). EMFI Working Paper No. 1 - 2009, The European Journal of Finance, Forthcoming, DOI:10.1080/1351847X.2011.649216, Available at SSRN: https://ssrn.com/abstract=1578800 or http://dx.doi.org/10.2139/ssrn.1578800

Roberto Savona (Contact Author)

University of Brescia - Department of Economics and Management ( email )

Contrada Santa Chiara, 50
BRESCIA, BS 25122
Italy

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