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Estimating hedge fund leverage

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  • Patrick M McGuire
  • Kostas Tsatsaronis

Abstract

Hedge funds are major players in the international financial system and nimble investment strategies including the use of leverage allow them to build up large positions. Yet the monitoring of systemic risks posed by the build-up of leverage is hampered by incomplete information on hedge funds' balance sheet positions. This paper describes how an extension of "regression-based style analysis" and publicly available data on fund returns yield an indicator of the average amount of funding leverage used by hedge funds. The approach can take into account non-linear exposures through the use of synthetic option returns as possible risk factors. The resulting estimates of leverage are generally plausible for several hedge fund families, in particular those whose returns are well captured by the risk factors used in the estimation. In the absence of more detailed information on hedge fund investments, these estimates can serve as a tool for macro-prudential surveillance of financial system stability.

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Bibliographic Info

Paper provided by Bank for International Settlements in its series BIS Working Papers with number 260.

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Length: 41 pages
Date of creation: Sep 2008
Date of revision:
Handle: RePEc:bis:biswps:260

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Keywords: hedge funds; systemic risk; leverage; style analysis;

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References

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  1. Fung, William & Hsieh, David A., 2000. "Performance Characteristics of Hedge Funds and Commodity Funds: Natural vs. Spurious Biases," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(03), pages 291-307, September.
  2. Markus K. Brunnermeier & Stefan Nagel, 2004. "Hedge Funds and the Technology Bubble," Journal of Finance, American Finance Association, American Finance Association, vol. 59(5), pages 2013-2040, October.
  3. Stephen J. Brown & William N. Goetzmann & James Park, 1998. "Hedge Funds and the Asian Currency Crisis of 1997," NBER Working Papers 6427, National Bureau of Economic Research, Inc.
  4. Ren� M. Stulz, 2007. "Hedge Funds: Past, Present, and Future," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 175-194, Spring.
  5. Gupta, Anurag & Liang, Bing, 2005. "Do hedge funds have enough capital? A value-at-risk approach," Journal of Financial Economics, Elsevier, Elsevier, vol. 77(1), pages 219-253, July.
  6. John Kambhu & Til Schuermann & Kevin J. Stiroh, 2007. "Hedge funds, financial intermediation, and systemic risk," Economic Policy Review, Federal Reserve Bank of New York, Federal Reserve Bank of New York, issue Dec, pages 1-18.
  7. Tobias Adrian, 2007. "Measuring risk in the hedge fund sector," Current Issues in Economics and Finance, Federal Reserve Bank of New York, Federal Reserve Bank of New York, vol. 13(Mar).
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Citations

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Cited by:
  1. King, Michael R. & Maier, Philipp, 2009. "Hedge funds and financial stability: Regulating prime brokers will mitigate systemic risks," Journal of Financial Stability, Elsevier, Elsevier, vol. 5(3), pages 283-297, September.
  2. Andrew Ang & Sergiy Gorovyy & Gregory B. van Inwegen, 2011. "Hedge Fund Leverage," NBER Working Papers 16801, National Bureau of Economic Research, Inc.
  3. Bussiere, M. & Hoerova, M. & Klaus, B., 2012. "Commonality in hedge fund returns: driving factors and implications," Working papers, Banque de France 373, Banque de France.
  4. Jiaqi Chen & Michael L. Tindall, 2012. "Hedge fund dynamic market sensitivity," Occasional Papers 12-1, Federal Reserve Bank of Dallas.

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