Crisis and Hedge Fund Risk
AbstractWe study the effect of financial crises on hedge fund risk. Using a regime-switching beta model, we separate systematic and idiosyncratic components of hedge fund exposure. The systematic exposure to various risk factors is conditional on market volatility conditions. We find that in the high-volatility regime (when the market is rolling-down and is likely to be in a crisis state) most 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 a high volatility regime of the idiosyncratic risk, which could be attributed to contagion among hedge fund strategies. In our sample this event happened only during the Long-Term Capital Management (LTCM) crisis of 1998. Other crises including the recent subprime mortgage crisis affected hedge funds only through systematic risk factors, and did not cause contagion among hedge funds.
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Bibliographic InfoPaper provided by Department of Economics, University of Venice "Ca' Foscari" in its series Working Papers with number 2008_10.
Date of creation: 2008
Date of revision:
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Postal: Cannaregio, S. Giobbe no 873 , 30121 Venezia
Web page: http://www.unive.it/dip.economia
More information through EDIRC
Hedge Fund; Risk Management; High frequency data;
Other versions of this item:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G29 - Financial Economics - - Financial Institutions and Services - - - Other
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-05-24 (All new papers)
- NEP-FMK-2008-05-24 (Financial Markets)
- NEP-MST-2008-05-24 (Market Microstructure)
- NEP-RMG-2008-05-24 (Risk Management)
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