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A Bayesian approach to detecting nonlinear risk exposures in hedge fund strategies

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  • Giannikis, Dimitrios
  • Vrontos, Ioannis D.
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    Abstract

    This paper proposes a model that allows for nonlinear risk exposures of hedge funds to various risk factors. We introduce a flexible threshold regression model and develop a Bayesian approach for model selection and estimation of the thresholds and their unknown number. In particular, we present a computationally flexible Markov chain Monte Carlo stochastic search algorithm which identifies relevant risk factors and/or threshold values. Our analysis of several hedge fund returns reveals that different strategies exhibit nonlinear relations to different risk factors, and that the proposed threshold regression model improves our ability to evaluate hedge fund performance.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 35 (2011)
    Issue (Month): 6 (June)
    Pages: 1399-1414

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    Handle: RePEc:eee:jbfina:v:35:y:2011:i:6:p:1399-1414

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Hedge funds GARCH Market timing MCMC methods Model uncertainty Risk factors;

    References

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    1. Chen, Yong & Liang, Bing, 2007. "Do Market Timing Hedge Funds Time the Market?," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 42(04), pages 827-856, December.
    2. Andrew J. Patton, 2004. "Are "market neutral" hedge funds really market neutral?," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 24819, London School of Economics and Political Science, LSE Library.
    3. Fung, William & Hsieh, David A, 2001. "The Risk in Hedge Fund Strategies: Theory and Evidence from Trend Followers," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 14(2), pages 313-41.
    4. Vrontos, Spyridon D. & Vrontos, Ioannis D. & Giamouridis, Daniel, 2008. "Hedge fund pricing and model uncertainty," Journal of Banking & Finance, Elsevier, Elsevier, vol. 32(5), pages 741-753, May.
    5. K. J. Martijn Cremers, 2002. "Stock Return Predictability: A Bayesian Model Selection Perspective," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 15(4), pages 1223-1249.
    6. Eling, Martin & Faust, Roger, 2010. "The performance of hedge funds and mutual funds in emerging markets," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(8), pages 1993-2009, August.
    7. Alessio Sancetta & Stephen Satchell, 2005. "New test statistics for market timing with applications to emerging markets hedge funds," The European Journal of Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 11(5), pages 419-443.
    8. Mark Mitchell, 2001. "Characteristics of Risk and Return in Risk Arbitrage," Journal of Finance, American Finance Association, American Finance Association, vol. 56(6), pages 2135-2175, December.
    9. Fung, William & Hsieh, David A, 1997. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 10(2), pages 275-302.
    10. Capocci, Daniel & Hubner, Georges, 2004. "Analysis of hedge fund performance," Journal of Empirical Finance, Elsevier, Elsevier, vol. 11(1), pages 55-89, January.
    11. Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 17(1), pages 63-98.
    12. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, Elsevier, vol. 33(1), pages 3-56, February.
    13. Billio, Monica & Getmansky, Mila & Pelizzon, Loriana, 2012. "Dynamic risk exposures in hedge funds," Computational Statistics & Data Analysis, Elsevier, Elsevier, vol. 56(11), pages 3517-3532.
    14. Wegener, Christian & von Nitzsch, Rüdiger & Cengiz, Cetin, 2010. "An advanced perspective on the predictability in hedge fund returns," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(11), pages 2694-2708, November.
    15. Meligkotsidou, Loukia & Vrontos, Ioannis D., 2008. "Detecting structural breaks and identifying risk factors in hedge fund returns: A Bayesian approach," Journal of Banking & Finance, Elsevier, Elsevier, vol. 32(11), pages 2471-2481, November.
    16. Avramov, Doron, 2002. "Stock return predictability and model uncertainty," Journal of Financial Economics, Elsevier, Elsevier, vol. 64(3), pages 423-458, June.
    17. Ding, Bill & Shawky, Hany A. & Tian, Jianbo, 2009. "Liquidity shocks, size and the relative performance of hedge fund strategies," Journal of Banking & Finance, Elsevier, Elsevier, vol. 33(5), pages 883-891, May.
    18. Ping-Huang Chou & Huimin Chung & Erh-Yin Sun, 2005. "Detecting mutual fund timing ability using the threshold model," Applied Economics Letters, Taylor & Francis Journals, Taylor & Francis Journals, vol. 12(13), pages 829-834.
    19. Meligkotsidou, Loukia & Vrontos, Ioannis D. & Vrontos, Spyridon D., 2009. "Quantile regression analysis of hedge fund strategies," Journal of Empirical Finance, Elsevier, Elsevier, vol. 16(2), pages 264-279, March.
    20. Darolles, Serge & Gourieroux, Christian, 2010. "Conditionally fitted Sharpe performance with an application to hedge fund rating," Journal of Banking & Finance, Elsevier, Elsevier, vol. 34(3), pages 578-593, March.
    21. Giannikis, D. & Vrontos, I.D. & Dellaportas, P., 2008. "Modelling nonlinearities and heavy tails via threshold normal mixture GARCH models," Computational Statistics & Data Analysis, Elsevier, Elsevier, vol. 52(3), pages 1549-1571, January.
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    Cited by:
    1. Olmo, José & Sanso-Navarro, Marcos, 2012. "Forecasting the performance of hedge fund styles," Journal of Banking & Finance, Elsevier, Elsevier, vol. 36(8), pages 2351-2365.
    2. Del Brio, Esther B. & Mora-Valencia, Andrés & Perote, Javier, 2014. "Semi-nonparametric VaR forecasts for hedge funds during the recent crisis," Physica A: Statistical Mechanics and its Applications, Elsevier, Elsevier, vol. 401(C), pages 330-343.
    3. Horst, Jenke ter & Salganik, Galla, 2014. "Style chasing by hedge fund investors," Journal of Banking & Finance, Elsevier, Elsevier, vol. 39(C), pages 29-42.

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