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Dynamic Risk Exposure in Hedge Funds

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  • Monica Billio

    ()
    (Department of Economics, University Of Venice Cà Foscari)

  • Mila Getmansky

    (Isenberg School of Management, University of Massachusetts)

  • Loriana Pelizzon

    (Department of Economics, University Of Venice Cà Foscari)

Abstract

We measure dynamic risk exposure of hedge funds to various risk factors during different market volatility conditions using the regime-switching beta model. We find that in the high-volatility regime (when the market is rolling-down) most of the strategies are negatively and significantly exposed to the Large-Small and Credit Spread risk factors. This suggests that liquidity risk and credit risk are potentially common factors for different hedge fund strategies in the down-state of the market, when volatility is high and returns are very low. We further explore the possibility that all hedge fund strategies exhibit idiosyncratic risk in a high volatility regime and find that the joint probability jumps from approximately 0% to almost 100% only during the Long-Term Capital Management (LTCM) crisis. Out-of-sample forecasting tests confirm the economic importance of accounting for the presence of market volatility regimes in determining hedge funds risk exposure.

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Bibliographic Info

Paper provided by Department of Economics, University of Venice "Ca' Foscari" in its series Working Papers with number 2007_17.

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Length: 67
Date of creation: 2007
Date of revision:
Handle: RePEc:ven:wpaper:2007_17

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Keywords: Hedge Funds; Risk Management; Regime-Switching Models; Liquidity;

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Citations

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Cited by:
  1. Loriana Pelizzon & Monica Billio & Mila Getmansky, 2008. "Non-Parametric Analysis of Hedge Fund Returns: New Insights from High Frequency Data," Working Papers 2008_11, Department of Economics, University of Venice "Ca' Foscari".
  2. Nicole M. Boyson & Christof W. Stahel & Rene M. Stulz, 2008. "Hedge Fund Contagion and Liquidity," NBER Working Papers 14068, National Bureau of Economic Research, Inc.
  3. Giannikis, Dimitrios & Vrontos, Ioannis D., 2011. "A Bayesian approach to detecting nonlinear risk exposures in hedge fund strategies," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1399-1414, June.
  4. Szabolcs Blazsek & Anna Downarowicz, 2008. "Regime switching models of hedge fund returns," Faculty Working Papers 12/08, School of Economics and Business Administration, University of Navarra.

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