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Crisis and Hedge Fund Risk

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Author Info
Loriana Pelizzon () (Department of Economics, University Of Venice Cà Foscari)
Monica Billio () (Department of Economics, University Of Venice Cà Foscari)
Mila Getmansky () (Department of Finance and Operations Management Isenberg School of Management University of Massachusetts)

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Abstract

We 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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Paper provided by University of Venice "Ca' Foscari", Department of Economics in its series Working Papers with number 2008_10.

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Length: 23
Date of creation: 2008
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Handle: RePEc:ven:wpaper:2008_10

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Related research
Keywords: Hedge Fund Risk Management High frequency data

Find related papers by JEL classification:
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

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